Economic growth & international trade-International trade -features-International trade theories-Comparative cost theory-Opportunity cost theory-H.O theory-International Trade equilibrium

1. Prepared by
Jissy.C
Assistant Professor
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Ms.Jissy.C

2. Introduction
The term Trade in its common usage refers to
the exchange of goods ,wares & services
among people.
Trade
Internal
Trade
Wholesale
Trade
Retail Trade
International
Trade
Import Trade
Export
Trade
Entreport
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3. Features of International Trade
Immobile of resources
Heterogeneous Markets
Trade among different Nations
Different type of Currencies
Different Political groups
Geographical & Climatic Difference
Problem of Balance of Payments
High Transport costs
Different Economic Environment
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4.  Difference Between Internal & International Trades
1.Sovereign Political Entities :
 Difficulty of distances
 Inadequate Transport & communication
 Diverse Language ,Customs & Traditions
 Risks & Uncertainties
 Customs Formalities
 Shipping & insurance
 Foreign Trade Quotations
 Too Many Middlemen
2.Different Legal Systems
3.Different Monetary systems
4.Lower Mobility of factor of production
5.Differnce in Market Characteristics
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5. Gains From International Trade
1.International Specialization
Increased Production & Higher Standard of
Living
Availability of scare Materials
Equalization of prices between countries
Evolution of Modern Industry Society
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6. International trade theories
Absolute Advantage Theory: Adam Smith
 Adam smith Says that trade between two nations is based on
absolute advantage. When one nations is more efficient than
another in the production of one commodity but is less
efficient than the other nation in producing a second
commodity ,then both nations can gain by each specializing in
the production of its absolute disadvantage. This Process
helps in utilizing the resources in the most efficient way and
the output of both products will rise. Such an increase in the
output measures the gain from specialization in production
available to be shared between the two nations through trade.
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7.  David Ricardo,s Comparative cost Theory.
According to the labour theory, the value of
any commodity is determined by its labour
cost, It says that goods are exchanged
against each other as per relative amount of
labour involved in them. it says further that
prices of goods will be equal to their labour
,which may equalize the return to labour in all
productions and regions throughout the
country.
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8. Assumptions of the theory
There are only two countries ,say for example
A &B
Theory produce the same two commodities
say for example X& Y
There are similar taste in both countries
Labour is the only factor of production
The supply of labour is constant
All unit labour are homogenous
Price of two commodities are determined by
labour cost.
Commodities are produced under the law of
constant cost
Technological knowledge remains constant
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9. Law of comparative Advantage
The law of compartive advantage says if one
country is less efficient than the other country
in the production of both the commodities,
there is still basis for mutually beneficial
trade. The former nation should specialize in
the production of the commodity in which its
absolute advantage is lesser and export it
and import the commodity in which its
disadvantage is greater
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10. Criticism of David Ricardo comparative cost theory
 Uses only labour cost & ignore Non Labour costs
 Consider labour as homogenous
 Assumes similar taste in the both countries
 Considers usage of labour in fixed proportions
 Consider cost as fixed
 Fails to consider transportation costs
 Assumes free mobility of factors of production within the
country.
 Considers trade between two countries for two commodities
 Assumes full employment
 Assumes static Technical know-how
 Neglects the demand side of foreign trade.
 Fails to explain the distribution of gains from trade.
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11. Opportunity Cost Theory.
 Professor gottfried Haberler propounded the
Opportunity cost Theory In 1983.
 Opportunity cost of any commodity is the cost of next
bet alternative commodity is scarified.
 According the cost of any commodity is neither the
labour involved nor the money spent in the
production of a commodity but it is the sacrifice of
alternative product which could have produced.
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12. Assumptions
 There are only two nations
 There are only two commodities in both the nations.
 There are only two factors of production such as labour &
capital in both the nations.
 There is prefect competition in both the factor and commodity
markets.
 The price of each commodity equals its marginal money
costs.
 In each employment ,the price of each factor equals its
marginal vale productivity
 Supply of each factor is fixed
 In each country there is full employment
 No change in technology
 Factors are not mobile between two countries
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13.  Concept of Opportunity cost
 Trade under Constant Opportunity costs
 Trade under Increasing Opportunity costs
 Trade under Decreasing Opportunity costs
 The production possibility curve indicates different combinations of
two commodities that a country can produce with the given factor
endowments and technology. The slope of the production
possibility curve is determined by the ratio of units of the
commodity given up in order to have one unit of the other
commodity. This ratio is termed as a marginal rate of transformation
(MRT).
 If two commodities X and Y are being produced by a country and
some quantities of labour, capital and other inputs are diverted from
the production of Y to the production of X, the additional production
of X involves the sacrifice of some quantity of Y. In other words,
certain units of Y given up have been transformed into the marginal
unit of X. The rate at which marginal unit of X is being substituted
for certain units of Y is called the marginal rate of transformation.
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14. Constant Opportunity cost Curve
 Since the MRTxy is negative, the opportunity cost
curve or transformation curve slopes down from left
to right. The opportunity cost curve may be a straight
line, convex to the origin or concave to the origin,
depending on whether return to scale in a country is
constant, increasing or decreasing respectively
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15.  At every point on the straight-line opportunity cost curve AB in
Fig. 6.1 (a) the MRTxy remains equal, MRTxy = – δY/δX =
PP1/OQ1 = P1P2/Q1Q2. It also signifies that marginal costs of
X and Y remains unchanged and production of both the
commodities is governed by constant returns to scale or
constant opportunity cost. It implies that all factors of
production are equally efficient in all lines of production. Since
this is not true in real life, the production possibility curve is
not likely to be a falling straight line.
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16. Increasing Opportunity cost Curve
 In Fig. 6.1 (b), the opportunity cost curve AB is a falling convex
towards the origin, MRTxy in this case goes on decreasing.
 This happens when production is governed by increasing returns to
scale or the cost of X in terms Y goes on diminishing as less and
less units of Y are given up in order to have more units of X. Even
this situation is not realistic because larger production of X will
cause reduced significance of X for the commodity in terms of the
commodity Y. This figure, on the opposite, indicates increasing
marginal significance of X.
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17. Decreasing
 In Fig. 6.1 (c), the opportunity cost curve AB is a falling concave
curve towards the origin. In this case, MRTxy goes on increasing
(PP1/QQ1 < P1P2/Q1Q2).
 The opportunity cost curve assumes this slope, when production is
governed by diminishing returns to scale. As there is an increase in
the production of X commodity, MC of X rises while that of Y
decreases. This case seems to be more realistic because in this
situation, a greater availability of X commodity shows a decreasing
significance of this commodity in terms of units of Y commodity
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18. Superiority over comparative Cost theory
Dispense with the unrealistic assumption of
labour theory of value
Analyses the pre-trade and post-trade
situations completely
Highlights the Importance of factor substitution
Facilitates the easy measurement of
opportunity cost
Explains the time ,reason etc about trade
Explains about the complete specilalisation
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19. Criticism
Inferior as a tool of welfare evaluation
Fails to consider changes in factor supplies
Fails to consider preference for leisure against
income
Unrealistic assumptions.
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20. Hecksher –Ohlin theory
 According to the Hecksher –Ohlin theory the main
determinant of the pattern of production specialisation and
trade among regions is the relative availability of factor
endowments and factor prices. Different regions or countries
have different factor endowment and factor prices some
countries have plenty of capital where as others have plenty
of labour.Heckscher- ohlin theory States countries which are
rich in labour will export labour intensive goods and countries
which have plenty of capital will export capital intensive
goods.
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21. ASSUMPTIONS
 There are two countries says A and B.
 There are two commodities says X and Y
 There are two factors of production such as labour and
capital
 There is a perfect competition in both the commodity as
well as factor market
 Country A is labour- abundant and B is capital –rich.
 There is a full employment of resources
 There is perfect mobility of factors within the country but
between countries they are in immobile
 There is no change in technology that is both the
countries use it same technology
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22.  The technique used for the production of each
commodity in the same in both the countries
whereas technique for different commodities is
different.
 There are no transportation cost
 There is free and unrestricted trade between the two
countries.
 There are constant returns to the scale.
 Demand pattern, taste, preference etc of consumers
are same in both the countries.
 International transactions are confined only to
commodity trade.
 There is a partial specialisation. That is neither
countries specialise in the production of one
commodity. 22
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23.  Factor abundance in terms of factor prices
 The theory explains richness in factor and
dominance in terms of factor prices. According to
their definition of price criterion, a country, which has
relativity cheap capital and relatively costly labour is
considered as relative capital abundant irrespective
of its ratio of total quantities of capital to labour in
comparison with other country. To put it symbolically
 (PC/PL) A < (PC/PL) B
Where, P= Factor Price A& B Two countries.
C=Capital ,L= Labour
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24.  Here country A relatively capital abundant. Hence country A
will produce and export the capital intensive goods and import
labour intensive goods. On the other hand country B relatively
cheap labour when compared to country A and so it will
produce an export labor-intensive goods and import capital
intensive goods.
 Fig 4.1.
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25.  There are two countries namely, country A and country B.
 Commodity X is taken as the labour intensive commodity and
commodity y is taken as the capital intensive commodity.
 Commodity X is taken on the horizontal axis and commodity y
is taken on the vertical axis .
 XX is the isoquant ie. equal product curve of commodity x and
YY is that of commodity Y , which is of the same for both the
countries A& B.
 Factor price line a AA I denotes the relative factor price for
both the commodities X & Y in country A.
 Suppose each isoquant denotes one unit of their respective
commodity then one unit of y will be produced with OC
amount of capital and OD amount of labour in country A at
point E, where line AA1 which is isocost is tangent to a
isoquant YY.
 On the other hand one unit of X will be produced with the OM
amount of capital and ON amount of labour in country A.
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26. It is clear from figure 4.1 that to produce one
unit of Y country A uses more amount of
capital OC with OD of labour at a point E on
the a isoquant YY. But at a point L on the
isoquant XX, It uses less amount of capital
OM with more of labour ON to produce one
unit of X. Thus country A will produce the
relative capital abundant and cheap
commodity Y and export it to country B.
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27. Factor abundance in physical terms
 Another definition to explain the theorem is
physical terms of factor abundance. As per
this criterion, a country is relatively capital
abundant if it is endowed with the higher
proportions of capital to labour than the other
country.
Let country a is capital abandoned and
country day is labour abundant in the physical
criterion.
.
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28.  In the figure 4.2 the line AA1 represents the production
possibility curve of country A and BB1 represents the
production possibility curve of country B. The slopes of this
curve indicate that a commodity Y is capital intensive
commodity & X is labour intensive.
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29.  Suppose both the countries produce both the
commodities in the same proportion, they will produce
them along the ray OR. when both the countries
produce at irrespective points country A will produce at
point E where the factor price line ST touches the
production possibility curve AA1.
 Country A will produce more of commodity Y which is
cheaper to it and less of commodity X which is costly
to it while country B will produce at point F enough
where the factor price line KR touch the production
possibility curve BB1.
 It will produce more of commodity X which is cheaper
to it and less of commodity y which is costly to it. The
slope of the factor price line ST of country A which is
Steeper than the factor price line KR of country B that
is flatter proves it.
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30.  The difference between both factor lions TR on x axis
shows that commodity X is produced in more
quantities (OR) in country B as compared to quantity of
commodity X( OT) in country A.
 The difference between both factor price lines KS on Y
axis indicates that commodity Y is produced in more
quantity (OS) in country A relatively to OK quantity of Y
in country B . Hence Country A which is capital
abunant has a bias in favour of capital – intensive
commodity Y from the production side while the labour
anundant country B has a bias in favour of producing
labour intensive commodity X
 But the above analysis in physical terms denotes not
indicate that the capital abundant country will export
the capital intensive commodity Y and the labour
abandoned will export the labour intensive commodity
X.
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31.  The HO theory in terms of physical criterion will
be valid only when taste for each commodity in
both the countries are similar.
 it taste differ in both the countries and the capital
abundant country A consumes more of the capital
intensive commodity Y and the labour abundant
country B consumes more of labour intensive
commodity X.
 The HO theorem in terms of physical criterion
will be invalid. Thus it leads to the conclusion that
the capital intensive country will export the labour
intensive commodity and labour intensive
country will export the capital intensive
commodity.
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32.  Criticism of HO theory
 Over simplified assumption
 Static analysis
 Assumption Homogenous factor
 Assumptions of homogenous production technique
 Unrealistic assumption of identical taste and demand
patterns
 Assumption of constant returns to scale
 Ignore transport cost
 Neglect product differentiation
 Assumes relative factor proportion determine the
specialisation in exports
 Only part of the partial equilibrium analysis
 Ignore factor mobility
 Vague theory 32
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33. Knhfldj
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