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International Trade Paper - Comparative Advantage and Absolute Advantage

Essay by   •  July 31, 2011  •  Research Paper  •  1,125 Words (5 Pages)  •  2,264 Views

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International Trade

According to economic principles, trading is based on supply and demand of goods and services. Briefly discussed, there are two methods of trading, international and domestic. International trading is more complex with origins dating back thousands of years. After the World War II period, a worldwide movement toward a free trading policy ensued. As a result, the World Trade Organization (WTO) was created to negotiate and remove trade restriction. The WTO has enabled a more robust trading environment for the United States, especially with countries such as China and Japan in which there is a high demand for their goods and services. Items such as comparative and absolute advantage as well as import quotas and tariffs must be understood to maneuver properly within the international market.

Comparative Advantage and Absolute Advantage

In most businesses there is always some form of competition. It is the advantage over the competition that makes the market and businesses successful. One such advantage is the absolute advantage, defined as "the ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources" (Hubbard & O'Brien, 2010). A business can have an absolute advantage just by producing more goods or services than the competition. However, the competition can have a comparative advantage over another business when it can produce goods or services at a much lower opportunity cost than their competitor (Mankiw, 2008). When using the same or fewer resources to obtain equal results, this is referred to as comparative advantage. Some businesses will spend more money or resources just to produce more than their competition. The most profitable approach would be to use less money or resources so that the profit margin will be higher than the business spending more. When used in trade, the principle states, "The basis for trade is comparative advantage, not absolute advantage" (Hubbard & O'Brien, 2010). In trade it is best that a country pick an industry that would gives them a comparative advantage rather than an absolute advantage. The country could then trade for goods or services that would otherwise give them an absolute advantage if they would produce it themselves.

Effect of Import Quota on International Trade

Large countries such as the Unites States, actively participates in free trade. However, some factors may affect domestic industries as a consequence of free trade. The main factor affecting domestic buyer and seller is price, given that they should adjust domestic price according to world price. If the world price is lower than the domestic price, importing foreign good will benefit domestic buyers, although domestic sellers will be negatively impacted. Under this circumstance the United States government can intervene by applying import quotas and tariffs.

Import quota limits the quantity of goods to be imported into the country. The quota is divided into absolute quota and tariff quota. Government authorizes license to determinate holders to control importation of specific goods affected by world price. After the absolute quota reaches the limit established, tariff quota rules the price of continued importations until a specified. The price of tariff will be set above of foreign price, improving the arena for a domestic seller and worsen for the domestic buyer, given that the buyer has to pay an additional fee, making the item more expensive in the United States as opposed to the foreign market.

Effect of Tariff on International Trade

"Tariffs are taxes levied on imported goods" (I. Trade, 2009). After the government imposes a tariff to imports from determinate country for a specific good, the price

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