INTRODUCTION

It is important to understand why trade takes place between countries. The five basic reasons why trade may take place are summarized below:

1. Differences in Technology: Advantageous trade can occur between countries if the countries differ in their technological abilities to produce goods and services. Technology refers to the techniques used to turn resources- labour, capital, land into outputs -goods and services.
2. Differences in Resource Endowments: Advantageous trade can occur between countries if the countries differ in their endowments of resources. Resource endowments refer to the skills and abilities of a country’s workforce, the natural resources available within its borders-minerals, farmland, etc., and the sophistication of its capital stock (machinery, infrastructure, communications systems).
3. Differences in Demand: Advantageous trade can occur between countries if demands or preferences differ between countries. Individuals in different countries may have different preferences or demands for various products. For example, the Indonesians are likely to demand more rice than Europeans, even if consumers face the same price. Turkish people may demand more yoghurt, the Dutch more beer, and the Japanese more seaweed than Indians would, even if they all faced the same prices.
4. Existence of Economies of Scale in Production: The existence of economies of scale in production is sufficient to generate advantageous trade between two countries. Economies of scale refer to a production process in which production costs fall as the scale of production rises.

5. Existence of Government Policies: Government tax and subsidy programs alter the prices charged for goods and services. These changes can be sufficient to generate advantages in production of certain products. In these circumstances, advantageous trade may arise solely due to differences in government policies across countries.