Trade is essential to bridge the gap between demand and supply. There are two main reasons for international trade taking place. The first reason is the theory of comparative advantage. Adam Smith, also known as the ‘Grandfather of Capitalism’ came up with this theory which states that, countries must focus on the production of those commodities that they have in abundance.

For example: Country X is a leader in producing wine and country Y is a leader in the production of tea. Since country X has a comparative advantage over country Y in the production of wine, it can export the surplus wine that it produces to country Y. Similarly country Y can export its tea to country X. This is the principle of comparative advantage. The second reason for international trade taking place is unavailability of certain goods in the home country. Goods are imported when countries do not have the climatic conditions, raw materials or other resources to produce certain goods in their home countries.

There are two main types of trade, namely free trade and fair trade (also known as protectionism).

Free trade

The very term ‘Free Trade’ suggests the absence of limitations. Free trade involves few to no barriers to trade among countries for exchange of goods. Supporters of free trade believe in opening up the global market by keeping minimum restrictions in trade. The Fair Trade Federation's Annual Report describes the fair trade movement as "a global network of producers, traders, marketers, advocates and consumers focused on building equitable trading relationships between consumers and the world's most economically disadvantaged artisans and farmers."

Free trade area

Certain groups of countries have agreed to take advantage of each other’s resources. To enable this, they have agreed to eliminate quotas, tariffs and trade agreements on most of their goods. This group of countries is known as a free trade area. An example of a free trade area is ASEAN Free Trade Area (AFTA) in South Asia which includes ten countries namely Indonesia, Brunei, Malaysia, Philippines, Singapore, Thailand, Cambodia, Laos, Myanmar and Vietnam.

Fair trade or Protectionism

Fair trade, also known as protectionism exists because the government is concerned about the nation’s interests. Governments enforce protectionist policies as they feel that this can reduce unemployment in the country. They also use protective measures to negotiate with other countries as well. For example country A can negotiate with country B saying that they would pull down their tariffs on steel if country B puts down its tariffs on sugar.

Protectionism involves enforcing tariffs, quotas, patents, environmental laws and trade agreements when goods are traded across countries. Proponents of protectionism feel that trade restrictions are necessary as they make the exchanges between countries more balanced. They claim that by limiting the open market economy, the government can concentrate on the domestic economy. The main objective of protectionism is the welfare of domestic producers.

Barriers to trade

Tariffs are essentially high taxes on imported goods which raise the prices of the imports thus creating an advantage for domestic products. Subsidies, is money that is paid to domestic producers that allow them to sell goods more cheaply than their foreign competitors. As price is an important factor while deciding to buy a product, these tariffs and subsidies help the national industries as the local people would first consider the product which is less expensive.

Implementation of quotas restricts the volume of goods that enter a particular country thus preventing foreign industries from gaining a large share of the market. A patent is exclusive rights granted by a state to an inventor or an assignee for a fixed period of time in exchange for a disclosure of an invention. A patent is the right granted by the government to an inventor for a specific period of time in exchange for disclosure of the invention. This prevents others from using, importing, offering or selling the invention. The granting of patents varies according to the law of that country.