International Trade Theories: Vipin P S4 Mba School of Management and Business Studies, MG University, Kottyam

International Trade Theories
VIPIN P
S4 MBA
SCHOOL OF MANAGEMENT AND BUSINESS STUDIES,
MG UNIVERSITY,KOTTYAM
International Trade Theories
• International Trade Theory deals with the

different models of international trade
• Developed to explain the diverse ideas of
exchange of goods and services globally.
• The theories of international trade have undergone a
number of changes.
An international trade theory can be seen as a
measure to address problems in a country.
Since 1970, the time of Adam Smith, economists
have shown that free trade is efficient and
leads to economic welfare.
……..
 Mercantilism
 Absolute Advantage
 Comparative Advantage (RicardIan Model)
 International Product Life-Cycle Theory
(Verrons)
 Factor Endowment Theory
 Free trade theory.
Mercantilism
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.
According to this theory other measures of countries' well being, such as

living standards or human development, are irrelevant.
Mainly Great Britain, France, the Netherlands, Portugal and Spain used
mercantilism during the 1500s to the late 1700s
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.
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.
The economic development was prevented when the

mercantilistic countries paid the colonies little for export and
charged them high price for import.
The main problem with mercantilism is that all countries

engaged in export but was restricted from import, another
prevention from development of international trade.
 To export is good, to import is to be avoided
 When you exported, you receive payment- currency based on gold standard
 Best thing to do is export as much as possible to gain as much gold as

possible
 Problem with theory is that excludes the fact that in some cases it is good to
import
 If you completely refuse to import, the population will have to do without

certain consumer items.
Theory of absolute advantage
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.
• Adam Smith: Wealth of Nations (1776) argued:
– Capability of one country to produce more of a
product with the same amount of input than
another country
– A country should produce only goods where it is
most efficient, and trade for those goods where it
is not efficient
• Trade between countries is, therefore, beneficial
• Assumes there is an absolute balance among
nations.
• … destroys the mercantilist idea since there
are gains to be had by both countries party to
an exchange
• … questions the objective of national
governments to acquire wealth through
restrictive trade policies
• … measures a nation’s wealth by the living
standards of its people.
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 –

Example
• Country A can produce 1000 parts per hour with 200 workers.
• Country B can produce 2500 parts per hour with 200 workers.
• Country C can produce 10000 parts per hour with 200 workers.
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.
Comparative Advantage (Ricard Ian Model)
 Countries should specialize in producing what

they are best at- things they have an absolute
advantage in
 Bread / peanut butter, peanut butter/bread
 Incentive to trade is based on each country
having an absolute advantage in a product
 In realty- this is unrealistic and quite
uncommon to happen this way
Comparative Advantage (Ricardian Model)
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.
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.

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.
Some countries have an absolute advantage in the production

of many goods relative to their trading partners.
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
• 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.
• 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.
Example
• 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.
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.

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International Trade Theories

• International Trade Theory deals with the

According to this theory other measures of countries' well being, such as

The economic development was prevented when the

The main problem with mercantilism is that all countries

 Best thing to do is export as much as possible to gain as much gold as

 If you completely refuse to import, the population will have to do without

same numberof employees. Country A has no absolute advantage because it can't

 Countries should specialize in producing what

In most cases, a straight-forward Absolute Advantage does

This model focuses perhaps the most important concept in

Some countries have an absolute advantage in the production

It is better for a country that is inefficient at producing a good

educated. He is also faster, better, and more productive at everything. He

and uneducated. He has an absolute disadvantage in all economic

activities. In some activities the difference between the two is great; in

according to comparative advantage then the young man will specialize in

Such an arrangement will increase total production for a given amount of

labor supplied by both men and it will benefit both of them.

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