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    eco unit 4 ppt

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    Abhijith Tojo

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    eco unit 4 ppt

    Uploaded by

    Abhijith Tojo
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    eco unit 4 ppt

    Uploaded by

    Abhijith Tojo

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    © All Rights Reserved
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    Why study trade theory?

    • Talks about benefits of international trade

    - Theories show why countries should trade for goods and services even when they can produce
    them domestically (Classical theories)

    • Talks about patterns of international trade

    Theories show why countries specialize the way they do (Factor endowment theories)

    Talks about the role of intervention

    Theories help articulate the role of government policy (tariffs, quotas, etc.)

     "International trade theories has long held that .....some trade is better than no trade, and
    more trade is better than less trade, and free trade is better than restricted trade..."
     Free trade is a situation where a government does not influence international trade through
    quotas and tariffs
     ".... Free trade is considered to be fair trade, because what is free must be fair..."

    An overview of trade theory

     Early thinking: Theory of Mercantilism


     Adam Smith: The theory of absolute advantage, 1776
     Ricardo: The theory of comparative advantage, 1817
     Heckscher-Ohlin theory: 20th century
     "New" trade theory based on economies of scale
     Technology gap theory
     Product Life Cycle theory

    Theory of Mercantilism

     A trade theory prevailed during 16th to 19th centuries


     The wealth of a nation is measured based on its accumulated wealth in terms of gold and
    silver
     Nations should accumulate wealth by encouraging exports and discouraging imports
     Theory of mercantilism aims at creating trade surplus and in turn accumulate nation's
    wealth

    Price-specie-Flow Mechanism

     First proposed by David Hume (1754) (Hume, David. Essays: Moral Political, Literary. 1754,
    1785. "Of the Balance of Trade")
     Explains how trade imbalances can self-correct and adjust under the gold standard
     Postulated that when a country has a positive balance of trade due to lower prices and less
    circulating money ("gold"), money begins to flow into the country due to exports, increasing
    the amount of money in the country

    Absolute Advantage Theory

     Adam Smith, 'An Enquiry into the Nature and Causes of the Wealth of Nations', 1776
     There is international benefit from trade
    - Everyone better off without making anyone worse off
     When one country can produce a unit of good with less cost than another country, the first
    country has an absolute (cost) advantage in producing that good
     Cost is considered based on number of labour units used

    Absolute Advantage Theory

    Assumptions:

    • Two countries (A&B), both producing two products (x&y)

    • Labour is the only factor of production and its productivity remains the same

    • Perfect mobility of labour between the sectors within a country• No mobility of labour between
    the countries

    • Assumes perfect competition

    -No transportation cost

    -No restrictions on the movement of goods between the countries (free trade)

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