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What Constitutes the Basis for Trade? Also What Are the Gains from Trade in Terms of Production and Consumption?

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International Trade and Competition

What constitutes the basis for trade? Also what are the gains from trade in terms of production and consumption?

The purpose of this report is to survey what constitutes the basis for trade in an international perspective and to discuss the gains in relation to production and consumption. By examining a range of recently published journal articles, magazine articles and internet sites on the topic of international trade this paper will describes the main basis’s of trade in common use today such as Factor-Endowments and overlapping demand, and will also examine their importance. In relation to the gains of international trade I will investigate a number of gains in relation to consumption and production. This paper will focus on international trade, which can be defined as the exchange of goods and services between nations. This type of trade gives rise to a world economy, in which prices, or supply and demand, are affected by global events.
A basic question in the study of international economics is 'why do nations trade?' or in other words, 'what is the basis of international trade?' The basis of all economic activities, including international trade, is essentially the human desire to improve its standards of living, i.e., to consume more and more of superior goods and services. It is this desire that creates a process of trade between the nations. Firstly you must look at the immediate basis for trade which is stemmed from the cost differences between nations, which is their natural and acquired advantages. Comparative advantage occurs when one nation can produce a good or service at a lower opportunity cost than another. This means nations can produce a good relatively cheaper than other nations. It is this theory that states that if nations specialise in producing goods where they have a lower opportunity cost - then there may be an increase in economic welfare of the nation. It is comparative advantage that provides the immediate basis for trade. At this point I will discuss in further detail other sources of the basis for trade.

As explained above the immediate basis for trade stems from the relative product price differences among nations. As a result of the fact that relative prices are determined by supply and demand conditions, such factors as resource endowments, technology, and national income are ultimate determinants of the basis for trade. I will now address the uses factor-endowment as the basis for trade. The factor-endowment theory suggests that the differences in relative factor endowments among nations underlie the basis for trade. The theory asserts that a nation will export that product in the production of which a relatively large amount of its abundant and cheap resource is used. Conversely, it will import commodities in the production of which a relatively scarce and expensive resource is used. The theory also states that with trade, the relative differences in resource prices between nations tend to be eliminated. An example of this would be how South Africa is highly abundant in natural resources and wildlife and culture and therefore focuses its international trade on these resources. This can be compared to China which is highly abundant in labour and therefore focuses its international trade on this resource.

Now I will address the Linder hypothesis of overlapping demand, which explains why some types of nations are most likely to trade with each other. Nations with similar per capita incomes will have overlapping demand structures and will likely consume similar types of manufactured goods. Therefore it can be seen that wealthy nations are more likely to trade with other wealthy nations, and poor nations are more likely to trade with other poor nations. Linder does not rule out all trade in manufactured goods between wealthy and poor nations. For the reason of unequal income distribution within nations, there will always be some overlapping of demand structures; some people in poor nations are wealthy, and some people in wealthy nations are poor. A high percentage of international trade in manufactured goods takes place among the relatively high-income nations: Japan, Canada, the United States, and the European nations. This explains that a basis for trade can be the like per captia income of nations.

Both theories are dissimilar as overlapping demand theory can be seen as a demand side analysis, while factor endowment theory can be seen as a supply side dynamic analysis. However both factor endowment and overlapping theory are sources of comparative advantage and sources of basis for trade which both rely on different factors to determine this basis. The basis of trade is an important step in the establishment of international trade links and allows the establishment of trade connections. In today’s environment no nation in the world can be economically independent without a decline in its economic growth. Even the richest countries buy raw materials for their industries from the poorest nations. If every country produces only for its own needs, then production and consumption of goods would be highly limited. Clearly, such situation hampers economic progress. Furthermore, the standard of living of the people all over the world would have no chance to improve. Subsequently I will look at the gains which are linked to international trade in relation to production and consumption uses South Africa as an example of these gains.

Another and a more important factor that forms the basis of international trade and its growth is that international trade is gainful to the trading nations. The ultimate gains of international trade are: (a) a larger supply of goods and services, and (b) availability of goods and services at a lower price. This adds to the eco­nomic welfare of the nation to the extent it depends on the material goods and services.

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