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The Theories Of Trade
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The Theories Of Trade


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  • 1. The Theories of Trade Learning Objectives • To understand the traditional arguments of how and why international trade improves the welfare of all countries • To explore the similarities and distinctions between international trade and international investment Evolution of Trade Theory • The Age of Mercantilism • Classical Trade Theory • Factor Proportions Trade Theory • International Investment and Product Cycle Theory • The New Trade Theory: Strategic Trade Mercantilism • Mixed exchange through trade with accumulation of wealth • Conducted under authority of government • Demise of mercantilism inevitable Classical Trade Theory • The Theory of Absolute Advantage – The ability of a country to produce a product with fewer inputs than another country • The Theory of Comparative Advantage – The notion that although a country may produce both products more cheaply than another country, it is relatively better at producing one product than the other Classical Trade Theory Contributions • Adam Smith—Division of Labor – Industrial societies increase output using same labor-hours as pre-industrial society • David Ricardo—Comparative Advantage – Countries with no obvious reason for trade can specialize in production, and trade for products they do not produce • Gains From Trade – A nation can achieve consumption levels beyond what it could produce by itself Factor Proportions Trade Theory • Developed by Eli Heckscher • Expanded by Bertil Ohlin Factor Proportions Trade Theory Considers Two Factors of Production • Labor • Capital Factor Proportions Trade Theory A country that is relatively labor abundant (capital abundant) should specialize in the production and export of that product which is relatively labor intensive (capital intensive). Product Cycle Theory • Raymond Vernon • Focus on the product, not its factor proportions • Two technology-based premises
  • 2. Product Cycle Theory: Vernon’s Premises • Technical innovations leading to new and profitable products require large quantities of capital and skilled labor • The product and the methods for manufacture go through three stages of maturation Stages of the Product Cycle • The New Product • The Maturing Product • The Standardized Product The Product Cycle and Trade Implications • Increased emphasis on technology’s impact on product cost • Explained international investment • Limitations – Most appropriate for technology-based products – Some products not easily characterized by stages of maturity – Most relevant to products produced through mass production The New Trade Theory: Strategic Trade Two New Contributions • Paul Krugman-How trade is altered when markets are not perfectly competitive • Michael Porter-Examined competitiveness of industries on a global basis Strategic Trade Krugman’s Economics of Scale: • Internal Economies of Scale • External Economies of Scale Strategic Trade • Government can play a beneficial role when markets are not purely competitive • Theory expands to government’s role in international trade • Four circumstances exist that involve imperfect competition in which strategic trade may apply • The Four Circumstances Involving Imperfect Competition: • 1.Price • 2.Cost • 3. Repetition • 4.Externalities • Barriers to Trade Why do countries produce goods and services that could be more cheaply purchased from other countries? Reasons: • To encourage local production • To help local firms export • To protect local jobs • Protect infant industries • Reduce dependency • Encourage local and foreign direct investment • Reduce balance of payment problems • Reduce or avoid dumping
  • 3. Commonly used barriers • Price based barriers- Ad valorem • Quantity limits-quotas- embargo • International price fixing- cartel • Financial limits- exchange control • Foreign investment controls-minority stakes, limiting profits etc Tariffs • Export tariff • Transit tariff • Specific duty • Ad valorem duty • Compound duty • dumping Non – tariff barriers- rules , regulations and bureaucratic • Quotas • Buy national restrictions • Customs valuation • Technical barriers • Counter trade