Theories of International Trade
Theories of International Trade
 Exchange of goods across the national borders
 Fundamental principals for international trade and shifting
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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
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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
4
10
 Acquired advantages Rice
Total Resource Available : 100 Units with each country
Resource Allocation: 50:50 for each product
Gains from Trade
Without Trade
With Trade
UK
India
Total
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: 50:50 for each product
Comparative Cost Advantage
produ
ct
WithoutTrade
With Trade
(Increasing the Rise
production)
With Trade
(Increasing the Tea
production)
UK
India
Total
UK
India
Total
UK
India
Total
Tea
5
10
15
0
15
15
0
18
18
Rice
10
12.5
22.5
20
6.25
26.5
20
2.5
22.5
37.5
20
41.25
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