Major Trade Theories

Essay by deezel71University, Bachelor'sA+, November 2008

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Countries have been trading with one another for hundreds of years to earn revenues and grow economies or because they do not have enough resources such as land, labor, and capital to satisfy all the needs of consumers inside the borders of their country. Trade occurs when one country has a product that is desired by another country. Trade allows both countries to obtain products that they cannot easily or affordably produce themselves. International trade among countries improves living standards within the countries as resources are used more efficiently and a greater variety of products exist.

Major Trade TheoriesThe theory of absolute advantage dictates that a country has an absolute advantage in the production of a product when it can produce more of that product with the same amount of resources than another country. Absolute advantage can also result in higher incomes for a country as one hour of labor output should increase and the country should become more efficient as a result of trade between countries (Salvatore, 2005).

Realistically, one country should have an absolute advantage over another country in the production of some goods. As an example, Saudi Arabia would have an absolute advantage in the production of oil compared to a country such as Japan.

The theory of comparative advantage states that a country has a comparative advantage in producing a product when its opportunity costs are lower than another country producing the same product. Opportunity costs are sacrificed in order to consume or produce another good. With comparative advantage, countries can gain from specializing in trading certain products. Production or total output should increase when countries specialize in producing and exporting goods and in turn lead to more efficient use of resources (Salvatore, 2005).

The Heckscher-Ohlin factor endowment theory "focuses on the difference in the relative...