Maximizing Production Through Trade
Luckily, your economy is not just limited to producing lumber and coffee. Economies can expand the amount of goods and services that they have through trade. Through comparative advantage, two economies can achieve a higher amount of lumber and coffee through trade. Let's look at an example.
We have two countries known as Bestland and Ableland. Both countries produce lumber and coffee. Bestland can produce one ton of lumber or half a ton of coffee in an hour because it has large forests that are easily accessed for logging. Ableland has extremely fertile farmland, but the forests are time-consuming to reach and the trees are slow growing. Because of this, it can make half a ton of lumber and one ton
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Ableland would have half a ton of lumber and one ton of coffee. Ableland has to pay an opportunity cost of one ton of coffee for every half a ton of lumber. Likewise, Bestland is paying an opportunity cost of one ton of lumber for every half a ton of coffee that it produces. Obviously, these countries need to make a change if they want to produce goods more efficiently. If Bestland only made lumber and Ableland only made coffee, they could trade the extra ton. As a result, both countries would have half a ton extra of one good without having to do any extra work.
In this scenario, Ableland has a comparative advantage in producing a ton of coffee because it gives up less lumber to produce a ton of coffee than Bestland. Likewise, Bestland has a comparative advantage in producing a ton of coffee because it gives up less lumber production to make that coffee than Ableland does.
This scenario is why economists say that international trade is a good thing. Some economies are exceptionally good at producing software, lumber, coffee, shirts or other products. By trading, resources are allocated better between different economies and nations
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Despite this, no country has an absolute advantage in everything. Because some countries still have a comparative advantage, there will be trade.
The Laws of Supply and Demand
If you squeezed every college class into just a five-minute summary, you would probably sum up Econ 101 as “supply and demand.” This is because supply and demand are two of the most fundamental ideas in all of economics. Supply is a term that shows how much a market can provide. The quantity supplied is a term that means the amount of a good producers will make at a certain price. The quantity demanded is the amount that people want to buy of a product at a certain price. Price changes based on the supply and the demand.
How Supply Works
The law of supply shows how much will be sold of a good at a certain price. If this were demonstrated on a graph, it would show an upward slope. As the price of a good rises, more producers will want to supply it. If the price of a good falls, fewer people will want to buy
To reiterate, let’s construct another example of two companies that produce oranges. Company number one is located in Florida where it’s the perfect environment to produce oranges. Company number two however is located in Toronto, which to be fair, isn 't a suitable environment to produce natural oranges, unless of course they’re produced in a green house. Although both companies are able to grow and produce oranges, company number one has the absolute advantage because they use the much cheaper and natural methods, hence the greater demand. This theory can be contradicted with the concept of comparative advantage, which in description means the ability to produce specific goods at a lower opportunity
Few governments will argue that the exchange of goods and services across international borders is a bad thing. However, the degree to which an international trading system is open may come into contest with a state’s ability to protect its interests. Free trade is often portrayed in a good light, with focus placed on the material benefits. Theoretically, free trade enables a distribution of resources across state lines. A country’s workforce may become more productive as it specializes in products that it has a comparative advantage. Free trade minimizes the chance that a market will have a surplus of one product and not enough of another. Arguably, comparative specialization leads to efficiency and growth.
Krugman defines comparative advantage as “the view that countries trade to take advantage of their differences” (1987, p. 132). Comparative advantage theories assume constant returns to scale and perfect competition. Krugman writes that trade exists when countries differ from one another in goods they have to offer, technology, or factor endowments. Although there are multiple models explaining the cause of trade, each differs as to what factors are included to explain why trade takes place. Economist Ohlin and authors Burenstam-Linder and Vernon began introducing counter-points to comparative advantage as early as the late 1950’s, saying that formal models of comparative advantage did not take into account all factors affecting international trade. International specialization and trade caused by increasing returns, as well as economies of scale and techn...
A single firm or company is a producer, all the producers in the market form and industry, and the people places and consumers that an Industry plans to sell their goods is the market. So supply is simply the amount of goods producers, or an industry is willing to sell at a specific prices in a specific time. Subsequently there is a law of supply that reflects a direct relationship between price and quantity supplied. All else being equal the quantity supplied of an item increases as the price of that item increases. Supply curve represents the relationship between the price of the item and the quantity supplied. The Quantity supplied in a market is just the amount that firms are willing to produce and sell now.
All nations can get the benefits of free trade by being specialized in producing goods they have a comparative advantage and then trade them with goods produced by other nations in the world. This is evidenced by comparative advantage theory. Trade depends on many factors, country's history, institution, size and. geographical position and many more. Also, the countries put trade barriers for the exchange of their goods and services with other nations in order to protect their own company from foreign competition, or to protect consumers from undesirable products, or sometimes it may be inadvertent.
Countries, in general, choose to produce a surplus of the product in which they specialize and trade it for a different surplus good of another country. It is only based on that that traders decide on whether they should export or import goods depending on comparative advantages. In this case of Sri Lanka and Kenya their opportunity cost is presented as follow: for 1000 bag of rice, 3000 bags of tea are produce therefore we can assume that the opportunity cost of 1 bag of tea is 1/3 bags of rice in Sri Lanka while in Kenya the opportunity cost is 1 bag of tea for 1 bag of rice. Based on that we can assert that Both counties can decide to trade with each other based on their specialization because Kenya’s opportunity cost is less than Sri Lanka’s opportunity cost of rice, therefore, Kenya has a comparative advantage in the production of rice while Sri Lanka has a comparative advantage in the production of
The Law of Comparative Advantage was introduced by David Ricardo in 1817 in his book ‘Principles of Political Economy and Taxation’. According to this classical theory, a comparative advantage exists for a country when it has a margin of superiority in the production of a certain commodity over others. Comparative advantage results from differing endowments in the factors of production like technology, natural endowments, climate, etc. among different countries. Therefore, each country exports the commodities which it can produce at a lower opportunity cost or, in other words, lower marginal cost of production and imports the rest. This would ultimately be beneficial for all countries engaging in free trade as each would gain through its specialization
The trade is one of important part of economy. We cannot imagine without trade on economy. When we started trade we might have lots of problems among the countries, so we need to have duties and regulations for the problems. Fro the solve problem we established organizations and agreements.
In order for international trade to work well, governments must allow the world market to determine how goods are sold, manufactured and traded for all to economically prosper. While all nations may have the capability to produce any goods or services needed by their population, it is not possible for all nations to have a comparative advantage for producing a good due to natural resources of the country or other available resources needed to produce a good or service. The example of trading among states comprising the United States is an example of how free trade works best without the interve...
Increased production- the free trade enables the countries to specialize in production of those commodities which are having comparative advantage. In international trade the size of the firm’s market is increased resulting in lower average costs and increased productivity.
The theory of absolute advantage, suggests that a country should export those goods and services for which it is more productive than other countries, and import those goods and services for which other countries are more productive than it is (Mahoney, Trigg, Griffin, & Pustay, 1998).
The market price of a good is determined by both the supply and demand for it. In the world today supply and demand is perhaps one of the most fundamental principles that exists for economics and the backbone of a market economy. Supply is represented by how much the market can offer. The quantity supplied refers to the amount of a certain good that producers are willing to supply for a certain demand price. What determines this interconnection is how much of a good or service is supplied to the market or otherwise known as the supply relationship or supply schedule which is graphically represented by the supply curve. In demand the schedule is depicted graphically as the demand curve which represents the amount of goods that buyers are willing and able to purchase at various prices, assuming all other non-price factors remain the same. The demand curve is almost always represented as downwards-sloping, meaning that as price decreases, consumers will buy more of the good. Just as the supply curves reflect marginal cost curves, demand curves can be described as marginal utility curves. The main determinants of individual demand are the price of the good, level of income, personal tastes, the population, government policies, the price of substitute goods, and the price of complementary goods.
Nowadays international trade is growing fast because of two main factors. Those factors include trade liberalization and technological progress. There are many and different arguments about the effects of trade liberalization and outsourcing. But the net effect of international trade is of cause differs from place to place.
That is, it is sensitive to price change, and also to the quantity demanded. This means that if many people are consuming a good, the demand is greater than if less people are consuming the good. To further clarify, take the example of attending college. In an environment where most of an individual's peers are going to attend college, the individual will see college as the right thing to do, and also attend college to be like his peers. However, in an environment where most of an individual's peers are not going to attend college, the individual will have a decreased demand for college, and is unlikely to attend.
A country will have a comparative advantage to the other country if it can gather the labor force and capital and provide the most favorable condition to the production of a product which will obviously lead to the productive efficiency. When an entrepreneur assess the condition in order to start a production the comparisons of inputs to produce and output is not only based to the past or the current prices but also the future prices which is the time it is provided to the market. While comparing the productive alternatives it is more important to consider the comparative advantage in which they specialize alongside profitable allocation of the assets. The results of the trade either profit or loss and the customer preference will help determine in which particular section they have the comparative advantage and will help determine where they need to specialize.