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International trade is the exchange of goods and services between two countries.
- Producers and consumers look beyond the borders of their own country to find goods and services that they want to buy and sell for the best price.
- When two countries trade with each other they tend to specialize in that good or service which uses their resources most efficiently (the term used to describe the good that uses resources most efficiently is comparative advantage). The countries then export that in which they have a comparative advantage and import that in which they do not.
- For example, assume Poland and Latvia were to decide to trade and it turns out that Poland has a comparative advantage in making socks and Latvia has a comparative advantage in making hats. Poland would start to export socks to Latvia and Latvia would export hats to Poland.
- Advantages: Because Latvia has the comparative advantage in hat making, it can make hats more cost effectively than the Polish hat producers. The Latvian hat will be cheaper, and once they begin trading, Polish consumers will enjoy cheaper hats. The Polish also get to specialize in that which they produce comparatively better – socks. At the same time, Latvian consumers get cheaper socks. Trade has led to a more efficient economic outcome.
- Disadvantage: The producers of hats in Poland and the producers of socks in Latvia are squeezed out of business by cheaper foreign imports. Polish hat makers are forced to give up the hat making business and either learn how to make socks or move to Latvia and make hats there. These individuals are unhappy with the change. It is possible that they are only good at making hats or can’t move and will ever be unemployment.
- Trade restrictions: The loss of jobs or a particular industry (hat making in the case of Poland) that can result from free trade leads to political pressure to restrict trade among countries. Governments can restrict trade by taxing imports (tariffs), or making it a law that only so much of a particular good can be imported (quotas).
- Trade restrictions are not as efficient as free trade and prevent consumers from enjoying lower prices. They also prevent a country from fully specializing in the goods with which it has a comparative advantage
- Trade restrictions have been justified if
- The trading partner is not operating on a level playing field.
- The industry that is lost as a result of free trade is important to maintain.
- A country may not want to depend solely on imports for all of its food or clothing.
- A country may not want to import its military equipment.