Overview

Why do we buy bananas from Ecuador and cars from Japan? Trade allows countries to specialize in what they do best and trade for the rest, making everyone richer (in theory).

Core Idea

Comparative Advantage: Even if one country is better at producing everything (absolute advantage), it should still specialize in what it is relatively best at, and trade for the other things.

Formal Definition (if applicable)

Balance of Payments: A record of all transactions made between entities in one country and the rest of the world over a defined period (exports - imports).

Intuition

Imagine a lawyer who is also the world’s best typist. Should they do their own typing? No. They can earn $500/hour lawyering and pay a typist $20/hour. Even though the lawyer is a better typist, their opportunity cost is too high. Same applies to countries.

Examples

  • Free Trade: No barriers (EU).
  • Protectionism: Using tariffs (taxes on imports) to protect local industries.
  • Exchange Rates: The price of one currency in terms of another.

Common Misconceptions

  • “Trade is zero-sum.” (If I buy a car from Japan, I get a car, they get money. We both wanted the trade. It’s positive-sum.)
  • “Imports kill jobs.” (They kill specific jobs but create others and lower prices for consumers.)
  • Globalization: The increasing integration of national economies.
  • Tariff: A tax on imports.
  • Quota: A limit on the quantity of imports.

Applications

  • Diplomacy: Trade sanctions as a tool of foreign policy.
  • Business: Supply chain management.
  • Development: Export-led growth strategies (e.g., Asian Tigers).

Criticism / Limitations

While trade increases total wealth, it creates winners and losers within a country (e.g., factory workers losing jobs to outsourcing). Without redistribution, inequality can rise.

Further Reading

  • Ricardo, On the Principles of Political Economy and Taxation
  • Krugman, International Economics