International Trade Theories

INTERNATIONAL

TRADE THEORIES

PRESENTATION ON

BY: ANKIT PORWAL

International Trade Theories

INTERNATIONAL TRADE THEORIES

MERCANTILISM

THEORY OF

ABSOLUTE

ADVANTAGE

THEORY OF COMPARAT

IVE ADVANTAG

E

Mercantilism

Thomas mun and others propagated this theory in U.K. between 16th &17th century.

Gold and silver were used as medium of exchange between countries.

Gold and silver were the mainstays of national wealth.

Country should always maintain trade surplus by exporting more than imported.

Government should intervene to achieve trade surplus by imposing tariffs and quotas on imports and subsidizing the exports.

CRITICISMS

Mercantilism is viewed as Zero Sum Game.

This theory is not suitable in the long run.

Decay of gold standard reduced the validity of

this theory.

THEORY OF ABSOLUTE ADVANTAGE

Adam smith propounded this theory in 1776. He believed that trade is a positive sum game. Free trade enables a country to produce a variety

of goods and services. This theory is based on the principle of division

of labour. The countries which produce goods more

efficiently than the other countries has an absolute advantage.

Country should never produce goods that it can buy at a lower rate from other countries.

Assumptions

Trade is between two countries

Only two commodities are traded

Free trade exists between the countries

The only element of cost of production is

labor.

EXAMPLE (IN RESOURCES)

TOTAL RESOURCES AVAILABLE: 200

Country Sugar Jute

India 10 20

Bangladesh 40 10

Production and consumption without trade.Country Sugar Jute

India 10 5

Bangladesh 2.5 10

Note: The resources are divided equally i.e.,100 resources for each.

Production with specializationCountry Sugar Jute

India 20 0

Bangladesh 0 20

Consumption after 6 tons of both are traded between them.

Country Sugar Jute

India 14 6

Bangladesh 6 14

Increase in consumption due to tradeCountry Sugar Jute

India 4 1

Bangladesh 3.5 4

EXAMPLE (IN TIME) Output per one day of labourcountry Pens Tape recorders

Japan 20 6

India 60 2

Production and consumption without trade.

Note: The time is divided equally for manufacturing i.e., 50%

Output per one day of labour

country Pens Tape recorders

Japan 10 3

India 30 1

Production with specialization

Output per one day of labor

Japan India

Pens 0 60

Tape recorders 6 0

Production and consumption with trade. Output per one day of labor

Japan India

Pens 30 30

Tape recorders 3 3

Note: terms of trade 10 pens = 1 tape recorder.Increase in consumption due to trade Output per one day of labor

Japan India

Pens 20 30

Tape recorders 3 2

PRODUCTION POSSIBILITIES WITH ABSOLUTE COST

ADVANTAGE

1 2 3 4 50

Tape recorders

50

40

302010

X

Y

Pens

6

60

------- Japan PP(CD)

C

B

A

D

E

F

japan

india

india

japan

…….. Indian PP(EF)Without trade:Japan-AIndia-B

With specialization: Japan-CIndia- F

IMPLICATIONS Both the countries can have more quantities of

both the products. Increases the standard of living due to increased

trade. Inefficiency in producing certain products in some

countries can be avoided.Global efficiency and effectiveness can be

increased by trading.Global labour productivity and other resources

productivity can be maximised.

CRITICISM No absolute cost advantage. Country size. Fixed cost of resources. Transport cost. Assumed away the effects of trade on income

distribution within the country. Absolute advantage for many products.

COMPARATIVE COST ADVANTAGE THEORY

This theory is propounded by David Ricardo in

1817.

This theory stress that comparative advantage arises from differences in productivity.

ASSUMPTIONS Each country has a fixed stock of resources.The only element of cost of production is

labour.Production is the subject to the law of

constant returns.All the units of labor homogeneousThere are no trade barriers.Trade takes place only between two

products and two countries.There is no cost of transportation.There is a perfect competition

EXAMPLE (IN RESOURCES)TOTAL RESOURCES AVAILABLE: 200RESOURCES REQUIRED TO PRODUCE 1 TON OF SUGAR AND JUTE

Country Sugar Jute

India 10 13.33

Bangladesh 40 20

Production and consumption without trade.Country Sugar Jute

India 10 7.5

Bangladesh 2.5 5

Note: India allots 100 resources for sugar and 100resources for jute.

Consumption after trading 4 tonsCountry Sugar Jute

India 11 7.75

Bangladesh 4 6

Increase in consumption due to tradeCountry Sugar Jute

India 1 0.25

Bangladesh 1.5 1

Country Sugar Jute

India 15 3.75

Bangladesh 0 10

Production with specialization

NOTE: India allots 150 resources for sugar & 50 resources for jute

PRODUCTION POSSIBILITIES WITH COMPARATIVE COST ADVANTAGE

5 10

15 200

JUTE

15

10

5

y

X

S

U

G

A

R

20

------- PP of B’desh(5/10)

2.5

7.53.75

A

B

C

D

E

F

Gindia

B’desh

-------PP of India (15/20) Without trade:Bangladesh: F(2.5-5)India-G(10-7.5)With specialization Bangladesh: D(0-10)India: E(15-3.75)

IMPLICATIONS Efficient allocation of global resources.

Maximization of global production at the

least possible cost.

Parity among world markets.

Demand for resources and products will

be optimized.

CRITICISM Only two countries Transportation costs Only two products Nothing about exchange rates Assumed away differences in prices of resources Mobility Services

QUERIES???