Benefits:

• Increased efficiency: Specialization allows countries to focus on producing goods and services they can produce most efficiently, thereby increasing productivity and efficiency. This can lead to lower production costs and prices for consumers, which can in turn increase overall economic welfare.
• Increased output: When countries specialize in producing goods and services they are most efficient at, they can increase their overall production of those goods and services. This can lead to a larger supply of goods and services, which can increase economic growth and welfare.
• Higher living standards: Specialization and free trade can lead to lower prices for goods and services, as well as increased output and efficiency. This can increase the purchasing power of consumers and lead to higher living standards.
• Increased competition: Free trade can increase competition among producers, which can lead to lower prices, higher quality goods and services, and increased innovation and efficiency.
• Access to a wider range of goods and services: By specializing in the production of certain goods and services, countries can trade with each other to access a wider range of goods and services. This can lead to greater economic welfare, as consumers have access to a wider range of goods and services.

Potential drawbacks

• Job displacement: Specialization and free trade can lead to job displacement in certain industries, as domestic producers may be unable to compete with foreign producers who can produce goods more efficiently or at a lower cost. This can lead to unemployment or a shift in the types of jobs available in an economy.
• Unequal distribution of benefits: The benefits of specialization and free trade may not be evenly distributed among all individuals or industries within a country. Some individuals or industries may benefit more than others, while some may suffer as a result of increased competition from foreign producers.
• Loss of domestic control: Specialization and free trade can lead to increased dependence on foreign producers for certain goods and services. This can lead to a loss of domestic control over the production and distribution of certain goods, which can be problematic in certain circumstances, such as during a global crisis or conflict.
• Environmental concerns: Specialization and free trade can lead to increased production and consumption of goods, which can have negative environmental impacts. Increased transportation and production can lead to higher levels of pollution and carbon emissions, which can be detrimental to the environment.
• Social concerns: Free trade agreements may not account for social concerns, such as labor rights or human rights, in the countries involved in trade. This can lead to exploitation of workers or other human rights violations.

• Terms of trade: the ratio of a country's export prices to its import prices.
  • Measure the volume of imports an economy can receive per unit of exports
• Improving terms of trade means that an economy can import more goods for each unit of export
  • prices of exports become relatively higher than prices of imports

Causes of changes in terms of trade

• Changes in global supply and demand for a country's exports and imports can affect the terms of trade.
  • If demand for a country's exports increases, while the global supply of the same goods remains relatively constant, the country's terms of trade will improve, as the prices for its exports will increase relative to the prices for its imports.
  • If supply of a country's exports increases while demand remains constant, or if demand for a country's imports increases while supply remains constant, its terms of trade will deteriorate.
• Changes in exchange rates can affect a country's terms of trade.
  • If the exchange rate for a country's currency appreciates (increases) relative to the currencies of its trading partners, its exports become relatively more expensive and its imports become relatively cheaper. This can lead to a deterioration in its terms of trade.
  • Conversely, if the exchange rate depreciates (decreases), its exports become relatively cheaper and its imports become relatively more expensive, leading to an improvement in its terms of trade.
• Changes in productivity can also affect a country's terms of trade.
  • If a country's productivity increases, it can produce more of its exports with the same amount of inputs, leading to an increase in the global supply of its exports. This can lead to a deterioration in its terms of trade.
  • If a country's productivity decreases, its exports become relatively more expensive and its imports become relatively cheaper, leading to an improvement in its terms of trade.
• Changes in trade barriers, such as tariffs, quotas, and other trade restrictions, can affect the terms of trade.
  • If a country lowers its trade barriers, it can increase the global demand for its exports and decrease the global demand for its imports, leading to an improvement in its terms of trade.
  • Conversely, if a country increases its trade barriers, it can decrease the global demand for its exports and increase the global demand for its imports, leading to a deterioration in its terms of trade.

Impact of changes in the terms of trade

• Balance of trade
  • If a country's terms of trade improve, the prices for its exports increase relative to the prices for its imports, and the country can purchase more imports with the same quantity of exports. This can lead to an improvement in the balance of trade.
  • If a country's terms of trade deteriorate, it will need to export more to purchase the same quantity of imports, leading to a deterioration in the balance of trade.

     

• Inflation
  • If a country's terms of trade improve, the prices for its exports increase relative to the prices for its imports, which can lead to higher inflation.
  • If a country's terms of trade deteriorate, the prices for its imports increase relative to the prices for its exports, which can lead to lower inflation.

     

• Economic growth
  • If a country's terms of trade improve, it can generate more revenue from its exports and invest in additional capital, which can lead to an increase in economic growth.
  • If a country's terms of trade deteriorate, it may have less revenue from its exports, which can limit its ability to invest in new capital and lead to a decrease in economic growth.

     

• Income distribution
  • If a country's terms of trade improve, the incomes of those who are involved in exporting goods and services may increase, while those who are involved in importing goods and services may see their incomes decrease.
  • If a country's terms of trade deteriorate, the opposite may occur, and the incomes of those involved in importing goods and services may increase relative to those involved in exporting goods and services.

• Assumptions of the models
  • For example, the models assume that resources are perfectly mobile within a country, but in reality, factors such as labor and capital may not be able to move freely.
  • The models assume that trade is always conducted freely and without any barriers, but in reality, there may be various trade barriers such as tariffs and quotas.
  • High transport costs may offset the comparative advantage.
• Short-term costs: In the short term, there may be costs associated with specialization and free trade.
  • For example, workers who are displaced by trade may experience temporary unemployment or a decrease in wages, and firms that are unable to compete in the global market may go out of business.
  • These short-term costs may create social and political pressures that can make it difficult to implement trade liberalization policies.
• Distributional effects: The benefits of specialization and free trade may not be evenly distributed within a country.
  • For example, certain regions or industries may be disproportionately affected by trade liberalization, leading to income inequality and regional disparities.
  • The winners of trade liberalization may also be able to capture a larger share of the gains from trade than the losers, leading to further income inequality.
• Strategic considerations
  • In some cases, a country may wish to protect certain industries or sectors for strategic reasons, such as maintaining national security or promoting infant industries.
  • In such cases, the theory of comparative advantage may not be applicable, and trade liberalization may be viewed as a threat to national interests.
• Environmental considerations
  • The theories of absolute and comparative advantage do not take into account environmental externalities associated with increased trade, such as increased pollution or depletion of natural resources. These externalities may have significant costs that are not reflected in market prices.