1 CHAPTER I INTRODUCTION TO INTERNATIONAL TRADE  Classical Theories of International Trade –Mercantilism –Absolute Advantage –Comparative Advantage  Interactions Between an Exporter and an Importer

2 Mercantilism  16th to 18th centuries in Europe  More exports than imports  Trade surplus------> More gold and silver  Protectionism------> Reduced international trade

3 Absolute Advantage  Adam Smith: 1776 –An Inquiry into the Nature and Causes of the Wealth of Nations –Goods and services available to citizens rather than gold and silver.  Should not produce all items a country needs  Should produce & export goods at an absolute advantage and import goods not at an absolute advantage

4 Absolute Advantage  Free Trade---> International division of labor --->More output to all trading partners  Natural Advantage: Climate and natural resources  Acquired Advantage: Product and process technology

5 Absolute Advantage Two countriesMexicoUSA Resources available100 To produce 1 ton of tomatoes410 To produce 1 ton of beans202

6 Absolute Advantage When each country uses a half of its resources,50, per product Two Countries MexicoUSATotal Tomato production M/T Bean production M/T

7 Absolute Advantage  When each country uses all resources,100, only for a product at an absolute advantage Two Countries MexicoUSATotal Tomato production M/T Bean production M/T

8 Absolute Advantage

9 Comparative Advantage  David Ricardo: 1817  “On the Principles of Political Economy & Taxation”  When a country does have or does not have an absolute advantage on two products,  Produce and export one product at a comparative advantage, relatively greater advantage than other product.  Import the other product not at a comparative advantage. –Gives up less efficient production & allocates more resources to more efficient production due to limited resources –Basis for economic development of less developed countries

10 Comparative Advantage  Productivity comparison between two countries Two countriesMexicoUSA Resources available100 To produce 1 ton of tomatoes 210 To produce 1 ton of beans 48

11 Comparative Advantage  When each country uses a half of its resources,50, per product without trade Two Countries MexicoUSATotal Tomato production M/T Bean production M/T

12 Comparative Advantage  When Mexico produces only tomatoes and USA produces only beans and trade Two Countries MexicoUSATotal Tomato production M/T Bean production M/T

13 Comparative Advantage  To make a comparison easier, if Mexico produces 30 tons of tomatoes by using 60 resources Two countries MexicoUSATotal Tomato production M/T Bean production M/T Increased production: 3.75 ( ) M/T of bean

14 Comparative Advantage  If Mexico produces 6.25 tons of beans by using 25 resources to make the total production of beans tons Two countriesMexicoUSATotal Tomato production M/T Bean production M/T Increased production: 7.5( ) M/T of tomato

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16 A ssumptions: Absolute and Comparative Advantage Limited resources No transportation costs No mobility of resources between countries

17 Interactions Between Exporter & Importer Exporter Overseas Importer U.S.A. Inquiry< Offer(Quotation) > Acceptance< Order< Letter of Credit< Shipping Docs > Payment< Customs Clearance X Distribution X