Trade theory(6)

TRADE THEORIES

PGDIB - I

TOPICS TO BE DISCUSSED

WHAT IS TRADE? WHY WE STUDY TRADE THEORY? DIFFERENT TRADE THEORIES

WHAT IS TRADE?

Trade is nothing but Voluntary exchange of goods and services between one person/organization & another with intension of gain from such trade.

WHY WE STUDY TRADE THEORIES?

To decide what should be imported and what should be exported i.e. EXIM policies of an Economy.

Government use these theories in designing different policies.

Managers use them to identify promising markets.

1. MERCANTAILISM

It is the first formal theory of trade. According to Mercantilist Version,

“A country’s wealth is measured by its holding of gold and silver, and the Country’s Goal should be to enlarge these holdings.”

1. MERCANTAILISM The Mercantilist advocates

Government intervention to achieve surplus balance trade i.e. exports should be increased and imports should be reduced.

Imports can be reduced by imposing tariffs and quotas.

Exports can be increased by providing subsidies.

FLAWS OF MERCANTAILISM

According to Davis Hume, in the Long run, no country could sustain a surplus on the balance of trade.

Government imports restrictions are paid by consumers in the form of higher taxes.

Government Subsidies of exports of certain industries are paid by taxes payers in form of higher taxes.

2. ABSOLUTE ADVANTAGE THEORY

This theory is proposed by Adam Smith.

Adam Smith says that trade is a Zero Sum game.

He advocates free trade to encourage a country’s wealth.

the basic argument by Adam smith was Countries differ in their ability to produce goods efficiently.

2. ABSOLUTE ADVANTAGE THEORY

This Theory answered a Question that, “ What goods and services should be exported and imported?”

According to this Theory,” A country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it.”

2. ABSOLUTE ADVANTAGE THEORY

Therefore Smith says that, ”A country should never produce that product at home which it can buy from some other country at comparatively low cost.”

Smith says that, “Global efficiency increases through free trade.”

3. COMPARATIVE ADVANTAGE THEORY

This theory is given David Ricardo. The concept of opportunity cost is

introduced in this theory. This theory explains that what

happens when one country has an absolute advantage in the production of all goods?

3. COMPARATIVE ADVANTAGE THEORY

David Ricardo showed that such a country may still derive benefits from International Trade.

A country which have absolute advantage in production of all goods can specialize in the production of those goods that the country produces most efficiently & buy those goods that it produces less efficiently from other countries.

4. FACTOR PROPORTION THEORY

This theory is given by Eli Heckscher and Bertil Ohlin.

So this theory is also known as HO Theory (Heckscher – Ohlin.

This theory is also known as Factor Endowment Theory.

This theory tells that, “What determine the product for which the country will have comparative advantage?”

4. FACTOR PROPORTION THEORY

According to Heckscher and Ohlin, “Factor Endowment (types of resources) varies from country to country.

Goods differ according to the types of factors that are used to produce them.

Difference in factor endowment leads to difference in factor costs.

4. FACTOR PROPORTION THEORY

According to HO Theory, “A country will have a comparative advantage in producing products that intensively use resources (factors of production) it has in abundance.

Ex: Saudi Arabia-abundance of crude oil reserves

India - abundance of unskilled labour US – abundance of capital China – abundance of labour Australia & Canada – abundance of land

5. PRODUCT LIFE CYCLE THEORY

This theory was developed in 1960s by Raymond Vernon of the Harvard Business School.

According to him, Location of the production shifts as products move through their life cycle.

5. PRODUCT LIFE CYCLE THEORY

There are 4 stages in Product Life cycle:- Introductory Stage Maturing Stage Standardized product Stage Declining Stage

5. PRODUCT LIFE CYCLE THEORY

INTRODUCTORY STAGE:- Also known as Innovation stage. In this stage, A firm develops & introduces

an innovative product. Early production generally occurs in the

domestic market. Better to keep production facilities close

to the markets & to the centre of decision making.

Companies may sell a small part of their production in foreign markets – Exports

5. PRODUCT LIFE CYCLE THEORY

MATURING STAGE:- In this stage, Demand of product

expands domestically & abroad. Domestic production reaches its peak Foreign competitors expands

productive capacity. Set up production unit in host

country to minimize distribution cost – Internationalization of Production.

5. PRODUCT LIFE CYCLE THEORY

STANDARDIZED PRODUCT STAGE:- In this stage, Product become more

standardized & prices becomes the main competitive weapon.

Production techniques are no longer exclusive & innovative.

Stiff competition from home as well as other developed countries.

Domestic production slumps.

6. PORTER’S THEORY OF NATIONAL COMPETITIVE

ADVANTAGE

This theory was given by Michael Porter in 1990 in Harvard Business School.

Porter said that, ”Success in International Trade comes from the interaction of four elements: Factor Conditions. Demand Conditions. Related & supporting Industry. Firm’s strategy, structure & rivalry.

6. PORTER’S THEORY OF NATIONAL COMPETITIVE

ADVANTAGE FACTOR CONDITIONS:-

Porter differentiated between Basic factors & Advanced factors.

Basic Factors: Land, Labor, Capital, Natural resources, etc.

Advanced Factors: Technology, Infrastructure, Education level of work force.

Porter said, “Favorable Factor conditions leads to favorable competitive conditions in the markets.”

6. PORTER’S THEORY OF NATIONAL COMPETITIVE

ADVANTAGE

DEMAND CONDITIONS: This represents the Consumer

Demand, If the consumers are well aware then

the firm has to develop high quality product & firm can compete internationally with good quality product & vice versa.

6. PORTER’S THEORY OF NATIONAL COMPETITIVE

ADVANTAGE

RELATED & SUPPORTING INDUSTRY:- These are the industries which gives

input to the firms & have spill over effect.

If the input produced by supporting Industry is superior i.e. of good quality, then the final product is also of good quality & the firm can compete internationally.

6. PORTER’S THEORY OF NATIONAL COMPETITIVE

ADVANTAGE

FIRM’S STRATEGY, STRUCTURE & RIVALRY:- Different Countries have different

ideologies. The more is the rivalry, the more

pressure to produce good product & firm can compete internationally with good quality product.

Therefore, Rivalry is important to develop world class product.

REFRENCES

International Business By V. Sharan