CHAPTER I INTRODUCTION TO
INTERNATIONAL TRADE
 Classical Theories of International Trade
– Mercantilism
– Absolute Advantage
– Comparative Advantage
 Interactions Between an Exporter and an
Importer
1
Mercantilism




16th to 18th centuries in Europe
More exports than imports
Trade surplus------> More gold and silver
Protectionism------> Reduced
international trade
2
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
3
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
4
Absolute Advantage
Two countries
Resources available
To produce 1 ton of tomatoes
To produce 1 ton of beans
Mexico
USA
100
100
4
10
20
2
5
Absolute Advantage
When each country uses a half of its resources,50,
per product
Two Countries
Tomato
production
Bean production
Mexico
USA
Total
12.50
5.00 17.50 M/T
2.50
25.00 27.50 M/T
6
Absolute Advantage
 When each country uses all resources,100, only
for a product at an absolute advantage
Two Countries
Mexico
USA
Total
Tomato
production
25.00
0.00 25.00 M/T
Bean
production
0.00
50.00 50.00 M/T
7
Absolute Advantage
Two Countries
Tomato
production
Bean production
Two Countries
Tomato
production
Bean
production
Mexico
USA
Total
12.50
5.00 17.50 M/T
2.50
25.00 27.50 M/T
Mexico
USA
Total
25.00
0.00 25.00 M/T
0.00
50.00 50.00 M/T
8
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
9
Comparative Advantage
 Productivity comparison between two
countries
Two countries
Mexico
USA
100
100
To produce 1 ton of
tomatoes
2
10
To produce 1 ton of
beans
4
8
Resources available
10
Comparative Advantage
 When each country uses a half of its
resources,50, per product without trade
Two
Countries
Mexico
USA
Total
Tomato
production
25.00
5.00
30.00 M/T
Bean
production
12.50
6.25
18.75 M/T
11
Comparative Advantage
 When Mexico produces only tomatoes and USA
produces only beans and trade
Two
Countries
Mexico
USA
Total
Tomato
production
50.00
0.00
50.00 M/T
Bean
production
0.00
12.50
12.50 M/T
12
Comparative Advantage
 To make a comparison easier, if Mexico produces
30 tons of tomatoes by using 60 resources
Two
countries
Tomato
production
Mexico
USA
Total
30.00
0.00
30.00 M/T
Bean
10.00
12.50
22.50 M/T
production
Increased production: 3.75 (22.50-18.75) M/T of
bean
13
Comparative Advantage
 If Mexico produces 6.25 tons of beans by using
25 resources to make the total production of
beans 18.75 tons
Two countries
Tomato
production
Bean
production
Mexico
37.50
USA
0.00
Total
37.50 M/T
6.25
12.50
18.75 M/T
Increased production: 7.5(37.50-30.00) M/T of
tomato
14
Two
Countries
Mexico
USA
Total
Tomato
production
25.00
5.00
30.00 M/T
Bean
production
12.50
6.25
18.75 M/T
Two
Mexico
USA
Total
countries
Tomato
30.00
0.00
30.00 M/T
production
Bean
10.00
12.50
22.50 M/T
production
Increased production: 3.75 (22.50-18.75) M/T of
bean
Two countries Mexico
USA
Total
Tomato
37.50
0.00
37.50 M/T
production
Bean
6.25
12.50
18.75 M/T
production
Increased production: 7.5(37.50-30.00) M/T of
tomato
15
Assumptions:
Absolute and Comparative Advantage
Limited resources
No transportation costs
No mobility of resources between countries
16
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
17