Concept of Comparative Advantage and the Principle Theories of Trade - Article Example

Concept of comparative advantage and the principle theories of trade The concept of comparative advantage in one of the most important concepts that could explains why trade occur especially between nations. In this concept, a country is said to have a comparative advantage on a certain product if its relative cost of producing that product is low compared to other products and low compared to its production costs in other countries. According to Smithson (1998), this concept is based on factor immobility across nations. As a result, one country finds itself with factors that favor production of a certain product more than the other products. As this concept indicates, countries find it economical to pay more attention to production of specific product in which they have a comparative advantage. As a result, they find themselves with surplus of this kind of products while incurring shortages of other products. The shortages make the country to device a mean to use in order to deal with shortages and the disposal of the surplus production. Dealing with shortages and surplus is what makes a country be involved in international trade. Through this kind of a trade, a country can dispose the product it produces in surplus and get the products, which it is, incurring shortages. There are also other theories that supplement the concept of comparative advantage in explaining why trade occurs. The principle ones are the theory of trade development and the theory of trade and international relationship. The theory of trade development explain that trade occur because of its profitability and its importance in the development of a nation. According to this theory, a country would only engage itself in trade with another country if it expects to gain from the process. The other theory explain that trade occur to promote and enhance international relationships between nations. According to this theory, the nations that trade with each other always have good diplomatic relationship. Sources of comparative advantage in national economies Various sources of comparative advantage that a national economy can have are always available. The major ones are technology, resource endowment, and the countries location (Dowson, 2005). Technology varies from one country to another, both in type and in its contribution to the comparative advantage of a nation. It is this technology that is used to create products from resource and as a result, a country with a specific unique technology would have a unique capability to create products from the resources. The country without the technology will need to rely on the country with the technology in order to create product from its resources. Thus, the country with high levels of technology would happen to have comparative advantage when it comes to productions that use technology. Resource endowment varies from one country to another. Each of the countries of the world has a specific resource in abundance. According to Dowson (2005), these resources are like stocks of labor, capital or natural resources like minerals and forests. The resources available define the kind of product a country can be able to produce effectively under minimum cost of production. Since other countries might lack the same resource, they would not be able to produce such a product with the same efficiency as this country. Therefore, a country gains a very great comparative advantage due to both the natural and manmade resource available. The location of a country is another major source of comparative advantage in a country. The location of a country is associated with presence of specific natural resource that gives a country the ability to produce specific products. Some countries might lack the resources but due to their location, they act as a link between the country that produces a specific product in surplus and the one that has shortages. Due to this, such a country would have a comparative advantage on all the products that pass through it to other countries. International movement of productive factors Productive factors like labor and capital move internationally from one country to another. Different aspects of production and business opportunities and threats among countries motivate the movement of these factors. Factors of production are believed to move from areas of great threat to areas of great opportunities. The opportunities and threats mainly depend on the factor of production and various characteristic of production in a country. According to Carbaugh (2010), these factors move only when allowed to and they move from places where they are in abundance to places where they are scarce. The movement of labor as a factor of production is motivated by the wages. As it can be clearly found out, the places with abundant labor have low wages. As a result, the laborers in those places become motivated to move from them in search for places where they can earn more for the same labor. Profits and interests on the other hand motivate the movement of capital as a factor of production. The investor would always move to places where they can have more returns to their investments. High interest rates reduce returns on investment and thus investors would always be moving from countries that charge high interest rates to ones that charge comparatively low interest rates on investments. The direction followed by movement of labor is always different from the direction followed by movement of capital in international trade. Labor moves from less developed countries to more developed ones while capital moves in the other way round. Economic effect of various forms of trade policies adopted by national governments Various forms of trade policies adapted by a national government have several economic effects to the country involved. The effect can either be positive or negative. The trade policies that can be adapted by a national government can either be categorized as a tariffs policy or a nontariff barrier policy. These policies can affect either a sector of a country’s economic or the whole economy. Therefore, a country should be very cautious when adapting and implementing its trade policies to minimize their negative effects while maximizing their positive effects. A major positive effect of tariffs is that they assist in the protection of the local industries. The tariffs make the cost of production and the cost of operation of the international industries to be much higher than those of the local industries do. As a result, the local industrials are assisted to gain a competitive advantage, which help them remain in operation. The major positive economic effect of nontariff barriers is that they limit the quantity of products brought in a country from other countries. This helps in stabilizing prices in those countries and thus stabilizing the economy of that country. The major negative effect that both tariffs and nontariff barriers have on an economy is that they act as a barrier to international trade. As a result, they reduce the country’s ability to dispose its surplus products and thus hinder the economic growth of that country. References Carbaugh, R. J. (2010). International Economics. Mason, OH: South-Western Cengage Learning. Dowson, G. (2005). Economics and Economic Change: Macroeconomics. London: Open University Press. Smithson, C. W. (1998). Managing Financial Risk: A Guide to Derivative Products, Financial Engineering, and Value Maximization. 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