Conditions that Prompt Trade

Comparative Advantage

• The principle of comparative advantage suggests countries will trade when they have a relative advantage in producing certain products.
• When a country can produce a good at a lower opportunity cost than another, it has a comparative advantage in that good.
• Opportunity cost refers to what must be given up to produce one more unit of a product (i.e., the cost of not producing something else).
• Trade allows countries to enjoy a range of goods and services they wouldn’t otherwise be able to produce efficiently.

Absolute Advantage

• Absolute advantage is when a country can produce a good more efficiently (using less resources) than another.
• If one country has an absolute advantage in all goods, trade can still be beneficial due to comparative advantage.

Economies of Scale

• Economies of scale can also encourage trade. As firms grow and output increases, they can reduce their average cost per unit - increasing competitiveness.
• International trade allows companies to achieve greater economies of scale by expanding their market beyond the national borders.

Factor Endowments

• Factor endowments refer to a country's resources, such as land, labour, capital and technology.
• A country will tend to export goods that require resources which are in abundant supply, and import those that require resources that are scarce.

Trade Policies

• Governments use trade policies like tariffs, quotas and subsidies to protect domestic industries, which can influence international trade.
• A high degree of protectionism can discourage trade, whereas a liberal and open trade policy can promote it.

Geographical Factors

• Proximity to other countries can also influence trade. Neighbouring countries are more likely to trade with each other due to lower transportation costs.
• Countries in a specific geographical region might share common characteristics or needs fostering regional trade.

Levels of Development

• Countries at different levels of development have different resource endowments, leading to different comparative advantages.
• Developed countries usually specialise in capital-intensive goods, whereas developing economies often focus on labour-intensive goods.

Exchange Rates

• The exchange rate between two countries' currencies affects the costs of imports and exports, influencing the volume and direction of trade.
• A depreciation in a country's exchange rate can make exports less expensive and thus more attractive to foreign buyers. Conversely, an appreciation can make exports more expensive and less competitive.