This document provides an overview of theories of international trade, beginning with mercantilism and including absolute advantage, comparative advantage, factor proportions, product life cycles, new trade theory, and national competitive advantage. It discusses key aspects of each theory, such as how mercantilism aimed to accumulate wealth through trade surpluses while exploiting colonies, and how comparative advantage shows that trade benefits both parties even if one country is less efficient. Theories have evolved over time to better explain patterns of trade.

1. Module 3
International Trade
DR. Ghada Mohamed AbdelFattah
ghada.Abdelfattah@alexu.edu.eg

2. International Trade
Purchase, sale, or exchange of goods and
services across national borders
 People have larger selection of products
 Important engine for job creation

3. International Trade Main Issues
International Trade Provides
Indications related to:
1- Export Performance.
2- International Demand.
3- Alternative Markets.
4- The Role of Competitors.

4. Trade and World Output
• World trade
• 80% merchandise
• 20% services
• World output impacts trade
• Growing output = growing trade
• Sluggish output = sluggish trade
• World trade grows faster
than world output

5. Trade Theory Timeline

6. Trade Theories try to answer one main
question:
Why do nations trade?

7. Trade Theories:
It was not until the fifteenth century that people tried to explain why trade
occurs. Efforts continue to refine existing trade theories and develop new
ones.
1- Mercantilism
- Nations should accumulate financial wealth, usually in the form of gold,
by encouraging exports and discouraging imports. Other measures of a
nation’s well-being, such as living standards or human development, are
irrelevant. Practiced from around 1500 to the late 1700s by European
nations, including Britain, France, the Netherlands, Portugal, and Spain.
How Mercantilism Worked?
-Trade was to benefit mother countries; colonies (in Africa, Asia, and
North, South, and Central America) were exploitable resources.

8. Mercantilism
Nations accumulate financial wealth by
encouraging exports and discouraging imports
Three pillars
• Maintain trade
surplus
• Government
intervention
• Exploit colonies
Inherent flaws
• World trade is
zero-sum game
• Constrains output
and consumption
• Limits colonies’
market potential

9. 2- Absolute Advantage Theory
Absolute advantage is the ability of a nation to produce a
good more efficiently than any other nation (produce a
greater output using the same, or fewer, resources)
Adam Smith reasoned that international trade should not be
burdened by tariffs and quotas, but should flow according to
market forces
A country should produce the goods in which it holds an
absolute advantage and trade with others to obtain the goods
it needs but does not produce efficiently
Ex: Rice-land has an absolute advantage in rice production
and Tea-land has an absolute advantage in tea production.

10. The theory of absolute advantage destroys the mercantilist idea that
international trade is a zero-sum game. Because both countries gain,
international trade is a positive-sum game.
The theory argues against restrictive trade policies and for nations to
instead open their doors to trade so their people obtain more goods more
cheaply in order to raise living standards.
Specialization and trade allows each to
produce and consume more
Riceland Tealand

11. 3- Comparative Advantage Theory
Is the ability of a nation to produce one good more efficiently
than it does with any other good, so that country should
specialize in the production of goods it has comparative
advantage in, and import other goods
Thus, trade is still beneficial even if one country is less
efficient in the production of two goods, as long as it is less
inefficient in the production of one of the two goods.
The theory has limitations because of its assumptions, like the
assumption of free transportation, and the assumption of only two
countries are involved in trade.
The theory was introduced by David Ricardo.

12. 4- Factor Proportions Theory
Countries produce and export goods that require
resources (factors) that are abundance in the country, and
import goods that require resources that are in short
Supply in that country.
Thus, the theory focuses on the productivity of the
production process.
Factor proportions theory breaks resources into two categories:
(1) labor, and (2) land and capital equipment.
It predicts that a country will specialize in products that require
labor if labor cost is low relative to land and capital costs, and
vice versa.

13. Leontief Paradox
Research discovered evidence opposite the
prediction of factor proportions theory
 U.S. exports are more labor-intensive than U.S. imports
although U.S. uses an abundance of capital intensive
- Try to explain how this is possible?
- What are the implications of this result?

14. 5- International Product Life Cycle
A company begins by exporting its product and later undertakes
foreign direct investment as a product moves through its life cycle

15. Stages of the Product Life Cycle
In new product stage, stage 1, the high purchasing power and demand of
buyers spur a company to design and introduce a new product concept.
Although initially there is virtually no export market, exports increase late
in the new product stage.
In the maturing product stage, stage 2, the domestic market and markets
abroad become fully aware of the existence of the product and its benefits.
Demand rises and is sustained over a fairly lengthy period of time. Near
the end of the maturity stage, the product generates sales in developing
nations, and manufacturing is established there.
In the standardized product stage, stage 3, competition from other
companies selling similar products pressures companies to lower prices in
order to maintain sales levels. An aggressive search for low-cost
production bases abroad begins and the home market may begin
importing.

16. 6- New Trade Theory
Fundamentals
 Gains from specialization
and increasing economies
of scale
 Companies first to market
create barriers to entry
 Government may help by
assisting home
companies
First-mover advantage
 Economic and strategic
advantage of being first to
enter an industry
 May create a formidable
barrier to market entry for
potential rivals

17. 7- National Competitive
Advantage
Nation’s competitiveness in an industry depends on the industry’s capacity to
innovate and upgrade, which in turn depends on four main determinants
(Porter’s Diamond)
(plus government and chance)
1- Factor conditions
2- Demand conditions
4- Firm strategy, structure, and rivalry
3- Related and supporting industries

18. 1- Factor Conditions
Basic factors Advanced factors
Nation’s resources
(large workforce, natural
resources, climate, and
surface features)
Result of investing in
education and innovation
(skill of workforce segments,
technological infrastructure)
Basic factors can spark initial production, but advanced
factors account for sustained competitive advantage

19. 2- Demand Conditions
Sophisticated home-market
buyers drive companies to
improve existing products and
develop entirely new products
and technologies
This should improve the
competitiveness of the entire
group of companies in a market

20. 3- Related and Supporting
Industries
Companies in an internationally competitive
industry do not exist in isolation
Supporting industries form “clusters” of economic
activity in the geographic area
Each industry reinforces the competitiveness of
every other industry in the cluster

21. 4- Firm Strategy, Structure,
and Rivalry
 Highly skilled managers are
essential because strategy
has lasting effects on firm
competitiveness
 Domestic industry whose
structure and rivalry create
an intense struggle to
survive, strengthens its
competitiveness

22. Bottom line for Business
This module explores the benefits of international trade
by introducing classical trade theories.
Trade can free a nation’s entrepreneurial spirit and
bring economic development.
New theories emerged to explain why countries trade.