International Trade- Basics, Resource Endowment, Adam Smith's Theory of Absolute advantage, Richard's theory of Comparative Advantage

1. Foreign Trade
Presented by
Mrunal K. Selokar [2013BCS065]
Suraj A. Bobade [2013BCS072]
Kirti N. Bajaj [2013BIT044]

2. Foreign Trade
• What is foreign trade?
• Foreign trade is the exchange of capital, goods, and
services across international borders or territories, which
could involve the activities of the government and
individual

3. Basis for Foreign Trade
• Resource Endowment
• Unequal distribution of resources
• Self sufficiency
• Gain from foreign trades

4. Resource Endowment
The basis of international trade is the difference in the
resource endowment of different nations
What is resource endowment?
“It is the availability of natural and man-made
resources that can be used to produce goods and
services.”

5. Unequal Distribution of resources
• Resource distribution refers to the distribution of resources,
including land, water, minerals, fuel and wealth in general among
corresponding geographic entities (here, countries).
• Countries may not have the resources that are important to them,
but trade enables them to acquire those resources from places
that do.
• Eg. Japan is a country with very limited natural resources, and yet
is one of the richest countries in Asia.

6. Self Sufficiency
• Definition:
“ It is the state of not requiring any aid, support, or
interaction with others for survival.”
• It is also termed as Autarky.
• Autarky is the quality of being self-sufficient.
• Autarky exists whenever an entity can survive or
continue its activities without external assistance or
international trade.
• No country can claim self sufficiency in it’s resource
requirements or a perfectly balanced supply of resources

7. Gain From Foreign Trades
• In economics, gains from trade refers to net benefits to
agents from allowing an increase in voluntary trading with
each other.
• Gains from international trade are in the form of increase
in production, cheaper goods and services, increase in
consumption, higher level of welfare and many other
related advantages including socio – politics.

8. Adam Smith’s Theory of Absolute Advantage
• INTRODUCTION:
• It may be possible for all countries to produce all commodities
they need, in spite of resource constraints. BUT, production cost
for goods for which the country is deficient in resource
endowment will be extremely high.
• Therefore, it is advantageous for a country to
• specialize in the production of commodities which it can
produce more efficiently
• Import the goods which it might produce at high cost.

9. Adam Smith’s Theory of Absolute Advantage
Absolute advantage:
The ability to produce a greater quantity of a good,
product, or service than competitors, using the same
amount of resources.
The theory says,
“A country tends to specialize in production of
commodities in which it has absolute advantage in cost of
production.”

10. Adam Smith first described the principle of absolute advantage
in the context of international trade, using labor as the only
input.

11. Example:
Country Rice Jute
India 30 60
Bangladesh 50 20
Per Quintal Labour Cost (Man-hour)
 India has an absolute advantage in rice production.
 Bangladesh has an absolute advantage in jute production.

12. 30/60=1 : 2
20/50=1 : 0.4
In their domestic trades,
• India will have to sacrifice 2 quintal of rice to produce 1 quintal of jute.
• Bangladesh will have to sacrifice 1 quintal of jute to get 0.4 quintal of rice.

13. By theory of absolute advantage,
• India would specialize in rice production and import jute.
• Bangladesh would specialize in jute production and import rice.
According to Adam Smith, trade between the two countries will prove
advantageous to both since both of them can avail, given the labor force, a
larger quantity of both commodities and at a lower cost.
• 50/30=1.67
• If India specializes in rice production, it can get 1.67 quintals of jute
for 1 quintal of rice.
• If Bangladesh specializes in jute production, it can import 0.67
quintals of rice for 1 quintal of jute.

15. Ricardian Theory of
Comparative Advantage

16. Assumptions of Ricardian Model
• Two countries, denoted home and foreign.
• Two final products.
• Each good uses only one input (labour) in
production.
• Labour is homogeneous in quality.
• Constant labour requirement per-unit of
output.
• No cost of transportation, no trade barriers.
• Perfect competition in factor and product
markets.

17. What Ricardian Theory
Says…
Ricardian Theory: A country exports that
commodity in which it has a comparative
labour-productivity advantage.

18. An Example…
Rice Jute
India 30 60
Bangladesh 50 80
Per Quintal labour cost

19. Domestic Exchange Rates of India
& Bangladesh
In India:
• 1 Quintal of Rice=30/60=0.5 Quintal Jute
• 1 Quintal of Jute=60/30=2 Quintal Rice
In Bangladesh:
• 1 Quintal of Rice=50/80=0.626 Quintal Jute
• 1 Quintal of Jute=80/50=1.6 Quintal Rice

20. Distribution of Gains
• Which country will gain more???
• Gainful exchange rates for India:
between 0.5 to 0.626 Quintals
• Gainful exchange rates for Bangladesh:
between 1.6 to 2 Quintals
• Gains are distributed on the basis of their
production efficiency.
• No country gains at the cost of other.

21. Criticism…
• Labour is not homogeneous
varies in skill & productivity
varies according to wages
• Labour is not the only factor
land & capital
state of technology
• Demand Side Ignored
• Other Criticisms

22. Thank You!