The document discusses several theories of international trade: 1. Mercantilism aimed to accumulate wealth through trade surpluses but overlooked other sources of wealth and was exploitative. 2. Absolute advantage explains trade based on a country's most efficient production, as with the UK producing more rice per unit than India. 3. Comparative advantage shows that even without absolute efficiency, mutual gains arise when countries specialize in their lower opportunity costs. It also covers new trade theories like economies of scale, the international product life cycle (IPLC) model, and Porter's Diamond model of competitive advantage. The IPLC model describes how a product evolves from introduction to growth, maturity, and decline

1. Theories
of
International Trade
1

2. Theory of Mercantilism
• It measures the wealth of a nation by the size of its accumulated
treasures i.e., gold & silver.
• Wealth (Gold) can be accumulated by encouraging exports &
discouraging imports.
• This theory aims at creating trade surplus.
• Limitations:
– Accumulation of wealth takes place at the cost of another trading
partner; a win-lose game & a zero-sum game for global wealth
(international trade).
– Supported only in short run.
– Overlooks other resources such as its natural resources, manpower &
its skill levels, capital etc.
– Used by colonial powers as a means of exploitation and not
development.
2

3. Theory of Absolute Advantage
• Ability of a country to produce a good more
efficiently and cost-effectively than any other
country.
Tea Rice
UK : 10 UK : 4
India – more UK – more
efficient in Tea
Units Units efficient in Rice
production production
India : 5 India :
Units 10 Units
3

4. Production Possibility Curves
Production with trade _____ India
_____ UK
India will produce
C 20 tones of Tea & 0
20
tones of Rice
UK will
A produce 0
Tea
10 tones of Tea
& 25 tones of
B Rice
5
D
5 10 121/2 20 25
Total tea output – 20 tones
Total rice output – 25 tones Rice 4

5. Production Possibility Curves
Production without Trade _____ India
_____ UK
India will produce
10 tones of Tea & 5
20 C tones of Rice
UK will
A produce 5
Tea
10 tones of Tea
& 12.5 tones
B of Rice
5
D
5 10 121/2 20 25
Total tea output – 15 tones
Total rice output – 17.5 tones Rice 5

6. Theory of Comparative Advantage
• Inability of a nation to produce a good more
efficiently than other nations, but its ability to
produce that good more efficiently compared
to the other good.
• Thus, the country may be at an absolute
disadvantage w.r.t. both the commodities but
the absolute disadvantage is lower in one
commodity than another.
6

7. Comparative advantage e.g.,…
UK India
Units required to produce 1 tone of tea 10 5
Units required to produce 1 tone of rice 5 4
Production without Production with trade Production with trade
Trade (Increasing rice production) (Increasing tea production)
UK India Total UK India Total UK India Total
Tea 5 10 15 0 15 15 0 18 18
(tones)
Rice 10 12.5 22.5 20 6.25 26.25 20 2.5 22.5
(tones)
37.5 41.25 40.5
Note: Assuming 100 units of resources available with each country 7

8. Measuring Comparative Advantage
RCAij = (Xij/Xwj)/(Xi/Xw)
Where,
Xij = ith country’s export of commodity j
Xwj = world exports of commodity j
Xi = total export of country i
Xw = total world exports
8

9. New Trade Theory…
• Countries trade to get benefits from their
differences & to increase their returns by
dilution of their fixed costs.
• Decrease in the unit cost of a product
resulting from large scale production is
termed as economies of scale.
• Economies of scale enables firm to reduce its
per unit average cost of production and
enhance its price competitiveness.
9

10. Economies of Scale – types…
Internal External
• Larger the size, higher are the • Cost per unit of output
economies of scale. depends upon the size of
• With decreased price, firms the industry not upon the
can monopolize the industry size of an individual firm.
thereby creating imperfect
• Help achieving global
market competition.
competitiveness.
• It lead a firm to specialize in a
narrow product line to • E.g., Automotive
produce the volume necessary component industry of India
to achieve cost benefits from & Semi-conductor industry
scale economies in Malaysia.
10

11. IPLC…
• International markets follow a cyclical pattern.
• Level of innovation & technology, resources, size
or market and competitive structure influence
trade pattern.
• Gap in technology and preference and the ability
of the customers in international markets also
determine the stage of IPLC.
• It explains the variations and reasons for change
in production and consumption patterns among
various markets over a time period.
11

12. IPLC… Other high
income countries
Exporting
Low-
income
Local countries
Innovation
1 2 3 4
0
Time
Innovating
Country
Importing
12

13. • Consumers willing to pay premium price for a new product.
Introduction • Rapidly changing techniques.
• Sales in home country
• Few competitors
• Price competition begins
Growth • Product Standard emerging
• Mass Production
• Increased exports to high-income countries
• Competition based on price and product differentiation
Maturity • Stable technology
• Production started in other high-income countries
• Price Competition
Decline • Lowest cost of production needed
• Production starts in developing countries
13

14. IPLC… Other high
income countries
Exporting
Low-
income
Local countries
Innovation
1 2 3 4
0
Time
Innovating
Country
Importing
14

15. • Consumers willing to pay premium price for a new product.
Introduction • Rapidly changing techniques.
• Sales in home country
• Few competitors
• Price competition begins
Growth • Product Standard emerging
• Mass Production
• Increased exports to high-income countries
• Competition based on price and product differentiation
Maturity • Stable technology
• Production started in other high-income countries
• Price Competition
Decline • Lowest cost of production needed
• Production starts in developing countries
15

16. IPLC… Other high
income countries
Exporting
Low-
income
Local countries
Innovation
1 2 3 4
0
Time
Innovating
Country
Importing
16

17. • Consumers willing to pay premium price for a new product.
Introduction • Rapidly changing techniques.
• Sales in home country
• Few competitors
• Price competition begins
Growth • Product Standard emerging
• Mass Production
• Increased exports to high-income countries
• Competition based on price and product differentiation
Maturity • Stable technology
• Production started in other high-income countries
• Price Competition
Decline • Lowest cost of production needed
• Production starts in developing countries
17

18. IPLC… Other high
income countries
Exporting
Low-
income
Local countries
Innovation
1 2 3 4
0
Time
Innovating
Country
Importing
18

19. • Consumers willing to pay premium price for a new product.
Introduction • Rapidly changing techniques.
• Sales in home country
• Few competitors
• Price competition begins
Growth • Product Standard emerging
• Mass Production
• Increased exports to high-income countries
• Competition based on price and product differentiation
Maturity • Stable technology
• Production started in other high-income countries
• Price Competition
Decline • Lowest cost of production needed
• Production starts in developing countries
19

20. Theory of Competitive Advantage
(Porter’s Diamond Model)
20

21. 21