Group 9 Traditional Theory of International Trade

Traditional
Theory
of International Trade
Trade Strategies and Policy Approaches for
Development
INTRODUCTION
TRADE
What? Why? How?
An exchange of goods To access products and Trade operates through
and services between services that are various mechanisms,
individuals, businesses, otherwise unavailable or including physical
or nations, facilitating more costly to produce marketplaces, digital
the distribution of locally, thereby platforms, and
resources to meet enhancing economic international trade
diverse needs and efficiency, consumer agreements, all
preferences. choice, and global designed to facilitate
economic growth. transactions and reduce
barriers.
Traditional
Theory
Also known as Classical Trade Theory
Encompasses foundational concepts:
1. Mercantilism
2. Absolute Advantage
3. Comparative Advantage
4. Factor Endowment Theory
MERCANTILISM
The term mercantilism was coined by

Marquis de Mirabeau in 1763 but was
popularized by Adam Smith, a Scottish
political economist, in 1776 in his book
The Wealth of Nations. The word is
derived from the Latin words merx,
meaning “commodity” and mercari,
meaning “to run a trade.”
Emerged in the 16th century in England
A country's wealth is determined by the
amount of its gold and silver holdings.
Mercantilism refers to an economic policy or
trade system wherein a country focuses on
maintaining a favorable trade balance.
Mercantilism suggests that it is in a
country's best interest to maintain a trade
surplus-to export more than it imports.
Zero-sum game - one in which a gain by one
country results in a loss by another
What is
Mercantilism?
Characteristis
of Mercantilism
Accumulation of Belief that
Large Population
Gold Wealth is Static
Gold was associated with At the heart of mercantilism The larger the nation, the more
wealth and power. It not only was the belief that wealth was wealth it could accumulate,
allowed nations to pay for static. As gold was rare, it was and the bigger its army. So
soldiers and expand the seen that there is only a larger populations were
empire but also for its limited supply. So importing associated with an increase in
symbolism of wealth more from one nation than it a nation's prosperity.
exported meant it was losing
wealth.
Characteristis
of Mercantilism
Positive Balance of Reliance on
State Monopolies
Trade Colonies
Mercantilists believed that Colonists relied on their The state had a monopoly in
by exporting more than they colonies not only for raw the fact that it was the only
imported, it would be able to materials but to ensure a net nation able to supply to its
acquire a net accumulation transfer of wealth and gold. colonies - so it was only able
of wealth from other nations. to import or export to the
mother country.
Characteristis
of Mercantilism
Trade Barriers
Many empires enforced a ban

on trade between its colonies,
as well as that of other
empires. The aim was to
suppress imports coming into
the country, without
completely eliminating the
goods that it needs.
How Mercantilism works
Differences in production technologies
between countries.
Two types of classical theories: Absolute

Advantage Theory and Comparative
Advantage Theory
Classical Theory
This theory was given by Adam Smith in 1776.
Also known as absolute cost differences.
Appears only when there are absolute cost
differences between countries.
When a country can produce a product more
efficiently than the other country.
Exports goods of production advantage and
imports goods of production disadvantage.
He took into consideration a two-country and
two-commodity framework for his analysis.
Absolute
Advantage Theory
Illustration
Drawbacks
Fails to explain mutual No benefit for countries Climate and resources not
benefit in free trade. without absolute advantage considered.
What if a country isn't good at

anything?
This theory was given by David Ricardo in 1871.
Just like absolute advantage, its main mechanism is
the difference in production technology between
countries.
Occurs when a country can produce a good or service
at a lower opportunity cost than another country.
If a country has an advantage of production of both
commodities, then compare the efficiency of both
goods.
A country should only produce goods where it is most
efficient and import goods in which it is less efficient.
Comparative
Advantage Theory
Illustration
Drawbacks
Ricardo’s Theory was based
Another notable defect is that
only on two countries and only
transportation costs are not
two commodities. International
considered in determining
trade is among many countries
comparative cost differences.
with many commodities.
Policy
A country should avoid anything that may restrict trade

with other countries.
Factor Endowment
Theory
The Factor Endowment Theory, also known as the

Heckscher-Ohlin (H-O) theory, is a foundational
concept in international trade that explains how and
why countries engage in trade based on their factor
endowments. Developed by Swedish economists Eli
Heckscher on the basis of work by his teacher,
Bertil Ohlin, the theory builds on David Ricardo’s
comparative advantage theory by focusing on a
country’s resources and production factors.
Definition
A nation will export the commodity whose production requires the
intensive use of the nation's relatively abundant and cheap factor and
import the commodity whose production requires the intensive use of
the nation's relatively scare and expensive factor.
Example:
The relatively labor-rich nation exports the relatively labor-intensive
commodity and imports the relatively capital-intensive commodity.
This means that Nation 1 exports X because X is the L-intensive

commodity and L is relatively abundant and cheap factor in Nation 1.
Assumptions of
Theory
1.) There are two nations (1&2), two commodities (X&Y), and two factors of
production (labor & capital). This is known as the "2x2x2 model."
2.) Both nations use the same technology in production.
3.) Commodity X is labor intensive and Y is capital intensive in both

nations.
4.) Both commodities are produced under constant returns to scale in

both nations.
5.) There is incomplete specialization in production in both nations.

Assumptions of
Theory
6.) Tastes are equal in both nations.
7.) There is perfect competition in both commodities and factor markets in

both nations.
8.) There is perfect factor mobility within each nation but no international
factor mobility.
Assumptions of
Theory
9.) There are no transportation costs, tariffs or other obstructions to the

free flow of international trade.
10.) All resources are fully employed in both nations.
11.) International trade between the two nations is balanced.

Thank You
Very Much!
Presented by:
Fabio Enrique Angeles

Franchesca Daniella Daculan
Lyzelle Shane Reyes
Fradel and Spies Co
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Traditional

The term mercantilism was coined by

Many empires enforced a ban

Two types of classical theories: Absolute

What if a country isn't good at

A country should avoid anything that may restrict trade

The Factor Endowment Theory, also known as the

This means that Nation 1 exports X because X is the L-intensive

2.) Both nations use the same technology in production.

3.) Commodity X is labor intensive and Y is capital intensive in both

4.) Both commodities are produced under constant returns to scale in

5.) There is incomplete specialization in production in both nations.

6.) Tastes are equal in both nations.

7.) There is perfect competition in both commodities and factor markets in

9.) There are no transportation costs, tariffs or other obstructions to the

10.) All resources are fully employed in both nations.

11.) International trade between the two nations is balanced.

Fabio Enrique Angeles

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