Theories Of International Trade

Theories of International Trade 1

Theory of Mercantilism • It measures the wealth of a nation by the size of its accumulated treasures i.e., gold & silver. • Wealth (Gold) can be accumulated by encouraging exports & discouraging imports. • This theory aims at creating trade surplus. • Limitations: – Accumulation of wealth takes place at the cost of another trading partner; a win-lose game & a zero-sum game for global wealth (international trade). – Supported only in short run. – Overlooks other resources such as its natural resources, manpower & its skill levels, capital etc. – Used by colonial powers as a means of exploitation and not development. 2

Theory of Absolute Advantage • Ability of a country to produce a good more efficiently and cost-effectively than any other country. Tea Rice UK : 10 UK : 4 India – more UK – more efficient in Tea Units Units efficient in Rice production production India : 5 India : Units 10 Units 3

Production Possibility Curves Production with trade _____ India _____ UK India will produce C 20 tones of Tea & 0 20 tones of Rice UK will A produce 0 Tea 10 tones of Tea & 25 tones of B Rice 5 D 5 10 121/2 20 25 Total tea output – 20 tones Total rice output – 25 tones Rice 4

Production Possibility Curves Production without Trade _____ India _____ UK India will produce 10 tones of Tea & 5 20 C tones of Rice UK will A produce 5 Tea 10 tones of Tea & 12.5 tones B of Rice 5 D 5 10 121/2 20 25 Total tea output – 15 tones Total rice output – 17.5 tones Rice 5

Theory of Comparative Advantage • Inability of a nation to produce a good more efficiently than other nations, but its ability to produce that good more efficiently compared to the other good. • Thus, the country may be at an absolute disadvantage w.r.t. both the commodities but the absolute disadvantage is lower in one commodity than another. 6

Comparative advantage e.g.,… UK India Units required to produce 1 tone of tea 10 5 Units required to produce 1 tone of rice 5 4 Production without Production with trade Production with trade Trade (Increasing rice production) (Increasing tea production) UK India Total UK India Total UK India Total Tea 5 10 15 0 15 15 0 18 18 (tones) Rice 10 12.5 22.5 20 6.25 26.25 20 2.5 22.5 (tones) 37.5 41.25 40.5 Note: Assuming 100 units of resources available with each country 7

Measuring Comparative Advantage RCAij = (Xij/Xwj)/(Xi/Xw) Where, Xij = ith country’s export of commodity j Xwj = world exports of commodity j Xi = total export of country i Xw = total world exports 8

New Trade Theory… • Countries trade to get benefits from their differences & to increase their returns by dilution of their fixed costs. • Decrease in the unit cost of a product resulting from large scale production is termed as economies of scale. • Economies of scale enables firm to reduce its per unit average cost of production and enhance its price competitiveness. 9

Economies of Scale – types… Internal External • Larger the size, higher are the • Cost per unit of output economies of scale. depends upon the size of • With decreased price, firms the industry not upon the can monopolize the industry size of an individual firm. thereby creating imperfect • Help achieving global market competition. competitiveness. • It lead a firm to specialize in a narrow product line to • E.g., Automotive produce the volume necessary component industry of India to achieve cost benefits from & Semi-conductor industry scale economies in Malaysia. 10

IPLC… • International markets follow a cyclical pattern. • Level of innovation & technology, resources, size or market and competitive structure influence trade pattern. • Gap in technology and preference and the ability of the customers in international markets also determine the stage of IPLC. • It explains the variations and reasons for change in production and consumption patterns among various markets over a time period. 11

IPLC… Other high income countries Exporting Low- income Local countries Innovation 1 2 3 4 0 Time Innovating Country Importing 12

• Consumers willing to pay premium price for a new product. Introduction • Rapidly changing techniques. • Sales in home country • Few competitors • Price competition begins Growth • Product Standard emerging • Mass Production • Increased exports to high-income countries • Competition based on price and product differentiation Maturity • Stable technology • Production started in other high-income countries • Price Competition Decline • Lowest cost of production needed • Production starts in developing countries 13

Theory of Competitive Advantage (Porter’s Diamond Model) 20

Theories Of International Trade

by Deepak Verma

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