Trade Theories

1. TRADE THEORIES Dr. Swati Sharma

2. TRADE THEORIES

3. WHY DO COUNTRIES TRADE?
1. Availability of products (natural resources,
new products, etc.)
2. International price differential as a
consequence of:
 Productivity differential
 Differences in technology
 Differences in factor endowments
3. Product differentiation and market structure

4. The aim of Trade Theory is to explain the
existing patterns of trade, the impact on the
domestic economy, and the type of public
policies that should be introduced to
increase a country's well-being.
TRADE THEORY

5. TYPES OF THEORIES
Classification
of
Theories
Traditional
Mercantilism
Absolute Advantage
Modern
Comparative Advantage
Factor Endowment
Theory
Country Similarity
Product Life Cycle
New Trade Theory
National Competitive
Advantage

6. TRADITIONAL
THEORIES

7. • This theory is given by Thomas Mun.
• Emerged in England in mid 16th Century .
• It assumes gold as a measure of country’s wealth.
• It is based on Zero Sum Game.
• Primary goal is to increase the wealth of the nation by
acquiring gold.
• More precious metals means a richer and more powerful
nation.
• Countries should increase gold by promoting exports and
discouraging imports.
• Drawback: This theory does not recognize anything except
gold as a measure of country’s wealth.
MERCANTILISM THEORY

8. This theory is given by Adam Smith in 1776 (Wealth)
of Nation
It is based on Productivity and Efficiency.
 Trade is Positive Sum Game.
Absolute advantage is when a country can produce a
product more efficiently than the other country.
Exports goods of production advantage and imports
goods of production disadvantage.
Sources ofAbsoluteAdvantage: Natural andAcquired
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ABSOLUTE ADVANTAGE THEORY

9. Fails to explain how free trade can be
advantageous to two countries when
one country can produce all goods
Country not having absolute advantage
can’tgainfromfree trade
Differences in climatic conditions & natural
resourceswon’tleadto absolute advantage
What if the country is bad at making
everything?
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DRAWBACKS

10. COMPARATIVEADVANTAGE THEORY
 This theory is given by David Ricardo in 1817.
 Comparative advantage occurs when a country can produce a good or
service at a lower opportunity cost than another country.
 Trade is positive sum game
 If country has advantage of production of both the commodities, then
compare the efficiency of both goods.
 A country should produce only goods where it is most efficient &
import those goods in which it’s less efficient.

11. • Ricardo's Theory was based on only two countries & only two commodities, but
international trade is among many countries with many commodities
• Another serious defect is that transportation costs are not considered in
determining comparative cost differences
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DRAWBACKS

12.  This theory is also known as Factor Proportion theory
or Heckscher and OhlinTheory or two factor theory.
 Given by Eli Heckscher and Bertil Ohlin in 1933.
 It explains international trade in terms of available
factors in the country.
 Countries will export the goods which make intensive
use of the factors that are locally available in the large
quantities and import goods that make intensive use
of factors that are locally scarce.
FACTOR ENDOWMENT THEORY

13. M O D E R N
THEORIES

14. • It is given by Swedish Economist Staffan B. Linder in 1961.
• It is just opposite of Factor Endowment Theory.
• Intra Industry Trade with differentiation should be undertake by similar
countries.
• Inter-Industry trade should be undertaken by the countries that are not
similar.
Country Similarity Theory

15. 4-
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• This theory is given by R .VERON in 1966
• Aproduct goes through the Product Life Cycle.
• Country where the product is first launched is the Innovator.
• At the end of the cycle the innovator becomes the Imported.
PRODUCT LIFE CYCLE

16. 4-
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17.  It is given by Paul Krugman in 1980.
 If a country having following factors ,then it can
become the exporter.
• Economies of Scale
• First MoverAdvantage
• Product Differentiation
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NEW TRADE THEORY

19.  It is given by Michael Porter in 1990.
 The factor can give competitive
advantage to
the country.
 Porter helps to understand the
determinant that are available to a
nation.
 Export goods from the industry where
the determinants are favourable
National Competitive Advantage