MODULE 5 - INTERNATIONAL TRADE THEORY.pdf

1. INTERNATIONAL
TRADE THEORY
INTERNATIONAL
TRADE THEORY
MODULE 5:
MODULE 5:
GROUP 1
GROUP 1

2. ANGULO
ANORE ABLAY
QUADRUPLE A
ADONA

3. OBJECTIVES
Understand why nations trade with each
other.
Be familiar with the different theories
explaining trade flows between nations.
Understand why many economists believe
that unrestricted free trade between nations
will raise the economic welfare of countries
that participate in a free trade system.

4. INTRODUCTION

5. An Overview of the Trade Theory

6. The Benefits of Trade

7. The Pattern of International Trade

8. The Pattern of International Trade

9. The Pattern of International Trade

10. The Pattern of International Trade

11. Trade Theory and Government Policy

12. MERCANTILISM
Mercantilism was an economic theory that emerged in England in
the mid-16th century. It argued that a nation's wealth and power
were measured by its accumulation of gold and silver. The primary
goal of mercantilism was to maintain a trade surplus, exporting
more goods than importing to accumulate precious metals.
Under mercantilism, governments intervened in the economy to
achieve this surplus. They imposed tariffs and quotas to limit
imports, while subsidizing exports. Additionally, military power was
often used to secure markets and sources of raw materials.

13. ABSOLUTE
ADVANTAGE
Absolute advantage refers to the ability of an individual, company,
region, or country to produce more of a good or service with the
same inputs or the same quantity of a good or service with fewer
inputs compared to another entity. It means being able to produce
at a lower cost per unit or more efficiently. Essentially, a country has
an absolute advantage in producing a product when it is more
efficient than any other country in producing it. For example, Adam
Smith pointed out that France has an absolute advantage in wine
production due to factors like favorable climate, good soils, and
accumulated expertise, making its wine industry the most efficient
in the world.

14. ABSOLUTE
ADVANTAGE
Greater Quantity with Same Inputs: An entity with absolute advantage can
produce more of a good or service using the same amount of resources or
inputs. This means they are more efficient in utilizing resources to increase
output.
1.
Same Quantity with Fewer Inputs: Alternatively, an entity with absolute
advantage can produce the same quantity of a good or service using fewer
resources or inputs. This indicates efficiency in the production process,
requiring less input to achieve the same output.
2.
Lower Absolute Cost per Unit: Absolute advantage implies that the entity can
produce the product or service at a lower absolute cost per unit compared to
others producing the same good or service. This could be due to a combination
of factors such as better technology, skilled labor, or natural resources
3.

15. HECKERSCHER-
OHLIN THEOR
The Heckscher-Ohlin theory of comparative advantage in
international trade states that countries tend to export goods that
utilize their relatively abundant factor of production and import
goods that utilize their relatively scarce factor. For example,
countries with abundant capital will export capital-intensive goods
and import labor-intensive goods, while countries with abundant
labor will do the opposite. Despite its plausibility, the theory doesn't
always align with actual trade patterns, as seen in the Leontief
Paradox where countries may export goods contradicting their
factor endowment.

16. HECKERSCHER-
OHLIN THEOR
Capital-intensive goods refer to products or industries that require
a significant amount of capital investment in machinery, equipment,
technology, and infrastructure for their production
Labor-intensive goods, on the other hand, are products or
industries that rely heavily on human labor for their production
process.

17. The Heckscher-Ohlin theory has been highly influential in
international economics due to its fewer simplifying assumptions
compared to Ricardo's theory. However, empirical tests, starting with
Leontief's famous study in 1953, have raised doubts about its validity.
The Leontief paradox, where the U.S. exports were less capital-
intensive than its imports despite its abundant capital, challenged
the theory. One possible explanation is the U.S.'s advantage in
producing innovative products with less capital intensity, contrasting
with mature technologies suited for mass production.
THE LEONTIEF
PARADOX

18. COMPARATIVE ADVANTAGE
Comparative advantage is a key principle in international trade and forms
the basis of why free trade is beneficial to countries. It makes sense for a
country to specialize in the production of those goods that it produces
most efficiently and to buy the goods that it produces less efficiently from
other countries, even if this means buying goods from other countries
that it could produce more efficiently itself. The theory of comparative
advantage shows that even if a country enjoys an absolute advantage in
the production of goods, trade can still be beneficial to both trading
partners.

19. COMPARATIVE ADVANTAGE
Example of Comparative Advantage
Consider two countries (France and the United States) that use labor as an input to produce two
goods: wines and cloth
In France, one hour of a workers labor can produce either 5 cloths or 10 wines
In US, one hour of a workers labor can produce either 20 cloths or 20 wines
To determine the comparative advantages of France and the United States, we must first
determine the opportunity cost of each output
France:
Opportunity cost of 1 cloth = 2 wine
Opporunity cost of 1 wine=1/2 cloth
United State
Opportunity cost of 1 cloth = 1 wine
Opporunity cost of 1 wine= 1 cloth

20. COMPARATIVE ADVANTAGE AND ITS
BENEFITS IN FREE TRADE
How does identifying each country comparative advantage aid in understanding
its benefits in free trade?
First, lets assume that the maximum amount of labor hours is 100 hours
France:
If all labor hours went into wine, 1,000 barrels of wine could be produced
If all labor hours went into cloth, 500 pieces of cloth could be produced
United States
If all labor hours went into wine, 2,000 barrels of wine could be produced
If all labor hours went into cloth, 2,000 pieces of cloth could be produced

21. In the mid-1960s, Raymond Vernon proposed the
product life-cycle theory that suggested that early in a
product’s life cycle all the parts and labor associated
with the product come from the area where it was
invented. After the product becomes adopted and used
in the world markets, production gradually moves away
from the point of origin.
THE PRODUCT LIFE
CYCLE THEORY

22. product moves to
developing countries,
which then export the
product to developed
countries.
STANDARDIZED
PRODUCT
The product enters the
world market because
its foreign demand
increases, and the
product is now exported
to different developed
countries.
MATURING
PRODUCT
produced or invented
by a developed country
at the first stage. At this
stage, the product is
not exported to other
countries and is
consumed domestically.
NEW
PRODUCT
IMPLICATION OF THE PRODUCT
LIFE CYCLE THEORY

23. NEW TRADE
THEORY
is a collection of economic models in international trade theory
which focuses on the role of increasing returns to scale and
network effects, which were originally developed in the late 1970s
and early 1980s.
The main motivation for the development of NTT was that, contrary
to what traditional trade models, would suggest, the majority of the
world trade takes place between countries that are similar in terms
of development, structure, and factor endowments.

24. Presented By : Larana Corporate