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International trade theories


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International trade theories

  1. 1. International Trade Theories <br />VIPIN P<br />S4 MBA<br />SCHOOL OF MANAGEMENT AND BUSINESS STUDIES,<br />MG UNIVERSITY,KOTTYAM<br />
  2. 2. International Trade Theory deals with the different models of international trade<br />Developed to explain the diverse ideas of exchange of goods and services globally.<br />The theories of international trade have undergone a number of changes.<br />International Trade Theories <br />
  3. 3. An international trade theory can be seen as a measure to address problems in a country.<br />Since 1970, the time of Adam Smith, economists have shown that free trade is efficient and leads to economic welfare.<br />
  4. 4. <ul><li>Mercantilism
  5. 5. Absolute Advantage
  6. 6. Comparative Advantage(RicardIan Model)
  7. 7. International Product Life-Cycle Theory (Verrons)
  8. 8. Factor Endowment Theory
  9. 9. Free trade theory.</li></ul>……..<br />
  10. 10. The trade theory that states that nations should accumulate financial wealth, usually in the form of gold, by encouraging exports and discouraging imports is called mercantilism. <br />According to this theory other measures of countries' well being, such as living standards or human development, are irrelevant. <br />Mainly Great Britain, France, the Netherlands, Portugal and Spain used mercantilism during the 1500s to the late 1700s<br />This trade theory suggested that a government can improve economic well being of the country by increasing exports and reducing imports, but turned out to be a flaw strategy.<br />Mercantilism<br />
  11. 11. Mercantilistic countries practised the so-called zero-sum game, which meant that world wealth was limited and that countries only could increase their share at expense of their neighbours.<br />The economic development was prevented when the mercantilistic countries paid the colonies little for export and charged them high price for import. <br />The main problem with mercantilism is that all countries engaged in export but was restricted from import, another prevention from development of international trade.<br />
  12. 12. <ul><li>To export is good, to import is to be avoided
  13. 13. When you exported, you receive payment- currency based on gold standard
  14. 14. Best thing to do is export as much as possible to gain as much gold as possible
  15. 15. Problem with theory is that excludes the fact that in some cases it is good to import
  16. 16. If you completely refuse to import, the population will have to do without certain consumer items.</li></li></ul><li>Theory of absolute advantage<br />A country has an absolute advantage over it trading partners if it is able to produce more of a good or service with the same amount of resources or the same amount of a good or service with fewer resources.<br />
  17. 17. Adam Smith: Wealth of Nations (1776) argued:<br />Capability of one country to produce more of a product with the same amount of input than another country <br />A country should produce only goods where it is most efficient, and trade for those goods where it is not efficient<br />Trade between countries is, therefore, beneficial <br />Assumes there is an absolute balance among nations.<br />
  18. 18. … destroys the mercantilist idea since there are gains to be had by both countries party to an exchange<br />… questions the objective of national governments to acquire wealth through restrictive trade policies<br />… measures a nation’s wealth by the living standards of its people.<br />
  19. 19. The theory of "Absolute Advantage" seems to make sense in situations where the circumstances of the geographic and economic environment are relatively simple and straight forward –<br />  <br />
  20. 20. Country A can produce 1000 parts per hour with 200 workers.<br />Country B can produce 2500 parts per hour with 200 workers.<br />Country C can produce 10000 parts per hour with 200 workers.<br /> Considering that labor and material costs are all equivalent, Country C has the absolute advantage over both Country B and Country A because it can produce the most parts per hour at the same cost as other nations. Country B has an absolute advantage over Country A because it can produce more parts per hour with the same numberof employees. Country A has no absolute advantage because it can't produce more goods than either Country B or Country C given the same input.<br />Example <br />
  21. 21. <ul><li>Countries should specialize in producing what they are best at- things they have an absolute advantage in
  22. 22. Bread / peanut butter, peanut butter/bread
  23. 23. Incentive to trade is based on each country having an absolute advantage in a product
  24. 24. In realty- this is unrealistic and quite uncommon to happen this way</li></ul>Comparative Advantage(Ricard Ian Model)<br />
  25. 25. Comparative Advantage(Ricardian Model)<br /> In most cases, a straight-forward Absolute Advantage does not exist in the real world. Some countries may have an advantage in one commodity, and also a slight advantage in another commodity - however there is still an opportunity for them to trade. <br />This model focuses perhaps the most important concept in international trade theory. Countries specialize in producing what they produce best. Unlike other models, the Ricardian framework predicts that countries will fully specialize instead of producing a broad array of goods.<br />  <br />
  26. 26. Country has a comparative advantage in the production of a good or service that it produces at a lower opportunity cost than its trading partners. <br />Some countries have an absolute advantage in the production of many goods relative to their trading partners.<br /> It is better for a country that is inefficient at producing a good or service to specialise in the production of that good it is least inefficient at, compared with producing other goods<br />
  27. 27. One country is said to have a comparative advantage over another country in the production of a particular good if it produces that good with lower opportunity costs.<br />Two countries can mutually benefit from trade even if one country is at an absolute advantage relative to another country in the production of every good.<br />
  28. 28. Two men live alone on an isolated island. To survive they must undertake a few basic economic activities like water carrying, fishing, cooking and shelter construction and maintenance. The first man is young, strong, and educated. He is also faster, better, and more productive at everything. He has an absolute advantage in all activities. The second man is old, weak, and uneducated. He has an absolute disadvantage in all economic activities. In some activities the difference between the two is great; in others it is small.<br />Example <br />
  29. 29. Despite the fact that the younger man has absolute advantage in all activities, it is not in the interest of either of them to work in isolation since they both can benefit from specialization and exchange. If the two men divide the work according to comparative advantage then the young man will specialize in tasks at which he is most productive, while the older man will concentrate on tasks where his productivity is only a little less than that of the young man. Such an arrangement will increase total production for a given amount of labor supplied by both men and it will benefit both of them.<br />