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 Natural Advantages Acquired advantages UKIndia Tea105 Rice410 Total Resource Available : 100 Units with each country Resource Allocation: 50:50 for each product

Gains from Trade Without TradeWith Trade UKIndiaTotalUKIndiaTotal Tea Rice

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 UKIndia Tea105 Rice54 Total Resource Available : 100 Units with each country Resource Allocation: 50:50 for each product

Comparative Cost Advantage produ ct Without TradeWith Trade (Increasing the Rise production) With Trade (Increasing the Tea production) UKIndiaTotalUKIndiaTotalUKIndiaTotal Tea Rice

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