Theories of International Trade

Agenda:
Implications of Trade Theories Different Theories of International Trade

Do you know?
Why do nations trade with each other? Is trading a zero sum game or a mutually beneficial activity? Why do trade patterns among countries exhibit wide variations? Can government policies influence trade?

Implications of Trade Theories

Trade theories provides: The conceptual base for international trade and Shifts in trade patterns. They also facilitate in understanding the basic reasons behind the evolution of a country as a supply base or market for specific products. d t

Theory of Mercantilism
It attributes and measures the wealth of a nation by the size of its accumulated treasures. It aims at accumulating financial wealth in terms of gold by encouraging exports and discouraging imports.

Limitations of Theory of Mercantilism

Accumulation of wealth at the cost of another trading p partner. A favorable balance of trade is possible only in short run. It overlooks other factors viz. natural resources, manpower and skills. This will result in a highly restrictive environment. These policies were used as a means of exploitation.

Theory of Absolute Advantage

Absolute advantage may be defined as ability of a nation to produce the goods more efficiently and cost effectively than any other country. Such efficiency is gained through: Repetitive production p p Switching production Long product runs

Advantage may be
Natural

Acquired Advantage

An illustration:

UK

India

Units required to produce one tonne of tea Units required to produce one tonne of rice

10 4

5 10

Production without trade

Production without trade
UK India Total

Tea (tonnes) Rice (tonnes)

5 12.5

10 5

15 17.5 32.5

Gains of specialization and trade

Production without trade
UK India Total

Production with trade

UK India Total

Tea (tonnes) 5 Rice (tonnes) 12.5

10 5

15 17.5 32.5

0 25

20 0

20 25 45

Theory of Comparative Advantage

Comparative Advantage may be defined as the inability of a nation to produce a good more efficiently than other nations but nations, its ability to produce that good more efficiently compared to the other good.

An illustration:

UK

India

Units required to produce one tonne of tea Units required to produce one tonne of rice

10 5

5 4

Production without trade

Production without trade
UK India Total

Tea (tonnes) Rice (tonnes)

5 10

10 12.5

15 22.5 37.5

Gains of specialization and trade

Production without trade
UK India Total

Production with trade

(Increasing rice production)

UK

India

Total

Tea (tonnes) Rice (tonnes)

5 10

10 12.5

15 22.5 37.5

0 20

15 15 6.25 26.25 41.25

Gains of specialization and trade

Production without trade
UK India Total

Production with trade

(Increasing tea production)

UK

India

Total

Tea (tonnes) Rice (tonnes)

5 10

10 12.5

15 22.5 37.5

0 20

18 2.5

18 22.5 40.5

Revealed Comparative Advantage

It is measured by a countrys share of world exports of a commodity divided by its share in total exports. RCAij = (Xij/Xwj)/(Xi / Xw) Where Xij = ith country export of commodity j Xw = world exports of commodity j p y Xi = total exports of country i Xw = total world exports

RCA index of specialization

Industry Basic manufacturers Electronics Fresh Food Leather Products Textiles T til Consumer electronics China 0.96 1.04 0.68 3.34 2.39 2 39 2.43 India Japan 1.36 0.23 2.23 2.18 4.27 4 27 0.10 0.99 1.64 0 0 0.55 0 55 1.20 Thaila nd UK US 0.63 1.33 1.52 0 0.61 0 61 0.92 0.60 0.81 1.55 0.63 2.33 0.40 1.40 0.34 0.79 0.56 0 79 0 56 2.11 1.01

Factor Endowment (Hecksher-Ohlin) Theory

A nation will export the goods whose production requires intensive use of the nations relatively abundant and cheap factors and import the goods whose production requires intensive use of its scarce and expensive factors. Theory suggests three types of relationships: Land-labour relationship dl b l i hi Labour-capital relationship Technological complexities

The Leontief Paradox

Wassily Leontief carried out an empirical test of the HeckscherOhlin Model in 1951 and found that the US exported more labour-intensive commodities and imported more capital intensive products which was contrary to the results of Heckscher-Ohlin Model of factor endowment.

Country Similarity Theory

Trade occurs between nations that have similar characteristics, such as economic, geographic, cultural, etc. However, in case of manufactured goods, cost was determined by similarity in product demands across countries rather than by relative production costs or factor endowments

The New Trade Theory

It elucidates that international trade enables a firm to

increase its output due to specialization by providing larger markets, resulting into enhancing its efficiency. It helps explain the trade patterns when markets are not perfectly competitive or when economies of scale are achieved by production of specific products.

International Product Life Cycle Theory

This explains the variations and reasons for change in production and consumption pattern among various markets over a time period.

Stages of International Product Life Cycle

The IPLC has four distinct identifiable stages that influences demand d d structure, production, d i marketing k i strategy, and d international competition as follows: Stage 1: Introduction Stage 2: Growth Stage Stage 3: Maturity Stage 4: Decline

Theory of Competitive Advantage

According to the theory, a firms home country environment is the main source of competencies and innovations often referred p to as the diamond mode, it focuses upon the four determinants:

Factor (Input) Conditions: created or inherited which include human resources, capital resources, physical infrastructure, administrative infrastructure and natural resources etc.

 Firm Strategy and Rivalry: refers to the extent of corporate investment, the type of strategy, and the intensity of local rivalry.

Demand Conditions: it includes the nature of demand, the size and growth patterns of domestic demand, and the way a nations domestic preferences are transmitted to foreign markets.

Related and Supporting Industries: Availability and quality of local suppliers and related industries.

Now you know

Why do nations trade with each other? Is trading a zero sum game or a mutually beneficial activity? Why do trade patterns among countries exhibit wide variations? Can government policies influence trade?

Any Question?