Theories of International Trade Theories of International Trade

Theories of International Trade

Theories of International Trade �Exchange of goods across the national borders �Fundamental principals for international trade and shifting trade patterns �Why do nation trade with each other? �Is trading is zero sum game or a mutually beneficial activity? �Why do trade pattern among countries exhibit wide variations? �Can government policies influences trade pattern?

Theory of Mercantilism �Wealth of nation measured by size of its accumulated treasure measured in terms of Gold �Encouraging exports and discouraging imports : trade surplus �Use of trade surplus to build powerful army and infrastructure �Exploitation of resources by colonial power �Active government intervention �Win-loose game, zero sum game �Not beneficial in the long run

Theory of Absolute Advantage �Adam Smith �The standard of living of a country can be improved either by importing goods not produced by it or by producing large quantities of goods through specialization and exporting the surplus �Absolute advantage refers to the ability of a country to produce goods more efficiently and cost-effective than any other country UK India �Natural Advantages Tea 10 5 Rice 4 10 �Acquired advantages Total Resource Available : 100 Units with each country Resource Allocation: 50 for each product

Gains from Trade Without Trade With Trade UK India Total Tea 5 10 15 0 20 20 Rice 12. 5 5 17. 5 25 0 25 32. 5 45

Theory of Comparative Advantage �David Ricardo �Country benefit from international trade even if it is less efficient that other nations in the production of two commodities. �Country should specialize in the production and export of commodity in which absolute disadvantage is less than that of another commodity UK India Tea 10 5 Rice 5 4 Total Resource Available : 100 Units with each country Resource Allocation: 50 for each product

Comparative Cost Advantage prod uct Without Trade UK Tea 5 Rice 10 With Trade (Increasing the Rise production) India Total UK 10 15 0 With Trade (Increasing the Tea production) India Total UK 15 15 12. 5 20 6. 25 26. 5 37. 5 20 41. 2 5 India Total 0 18 18 20 2. 5 22. 5 40. 5

Factor Endowment Theory �Hecksher Ohlin �Reasons for difference in commodity prices and comparative advantage between nations �Nation will export the commodity whose production require intensive use of nation’s relatively abundance and cheap factor and import the commodity whose production require intensive use of nation’s scarce resource �Leontief Paradox

Country Similarity Theory �Staffan B Linder �Trade pattern for primary product and manufacturing products �In the case of manufacturing products trade pattern based on demand across countries rather than production cost of factor endowment �Majority of trade occurs between countries having similar characteristics

The New Trade Theory �Concept of economies of scale to solve Leontief Paradox �Internal economies of scale � External economies of scale

International Product Life Cycle Theory �Introduction �Growth �Maturity �Decline

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