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    This document summarizes several theories of international trade: 1. Classical theories including comparative advantage theory by David Ricardo and absolute advantage theory by Adam Smith which assume countries specialize based on differences in production costs. 2. Factor proportions theory by Heckscher-Ohlin which says a country's comparative advantage depends on its factor endowments like capital and labor. 3. Other modern theories include skills theory, natural resources theory, scale economies theory, and product life cycle theory by Vernon which explains how products move from development to maturity in international trade.

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    This document summarizes several theories of international trade: 1. Classical theories including comparative advantage theory by David Ricardo and absolute advantage theory by Adam Smith which assume countries specialize based on differences in production costs. 2. Factor proportions theory by Heckscher-Ohlin which says a country's comparative advantage depends on its factor endowments like capital and labor. 3. Other modern theories include skills theory, natural resources theory, scale economies theory, and product life cycle theory by Vernon which explains how products move from development to maturity in international trade.

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    62 views20 pages

    Theories of International Trade

    Uploaded by

    GaurEesh
    This document summarizes several theories of international trade: 1. Classical theories including comparative advantage theory by David Ricardo and absolute advantage theory by Adam Smith which assume countries specialize based on differences in production costs. 2. Factor proportions theory by Heckscher-Ohlin which says a country's comparative advantage depends on its factor endowments like capital and labor. 3. Other modern theories include skills theory, natural resources theory, scale economies theory, and product life cycle theory by Vernon which explains how products move from development to maturity in international trade.

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    of 20

    Theories of International

    trade
    1. Classical Theory

    2. Modern theory
    Classical Theory
    1. Classical Theory of Comparative cost

    A country will specialize in the production


    of those items where its costs are lower
    than in other countries or it enjoys a
    comparative cost advantage
    David Ricardo
    Assumptions
    Two countries must produce the same two
    commodities
    Labour: homogeneous, only factor
    Same taste, no change in technology
    Wages determines the price
    Production is based on the law of constant returns
    No transportation costs
    Consumption, buying behaviour and affordability is
    same
    TEA MACHINE
    INDIA 80 90
    GERMANY 120 100
    TEA MACHINE
    INDIA 1 0.89
    GERMANY 1 1.20
    TEA MACHINE
    INDIA 1.12 1
    GERMANY 0.83 1
    Limitations
    Labor is the only factor of production which is
    homogeneous
    Raw materials have been ignored
    Labor is not used in the same fixed proportion
    Assumption of uniform wages in different countries
    Theory considers only the supply side: production
    costs
    No inclusion of demand factor
    2.Theory of Absolute Advantage
    A country should import only such goods that are
    produced at a higher costs than other countries

    A country should export only such goods that are


    produced at a lower cost than other countries.

    Wealth of Nations: By
    Adam Smith
    Modern Theories of International Trade
    1.Heckscher – Ohilin Theory: Factor Proportion Theory
    Source of a country’s comparative advantage depends on
    its factors of production
    Different countries have different factor endowments

    A country will specialize and export that


    product which is more intensive in that factor
    which is available in more quantity.
    It will import those goods which are more intensive in
    that factor of production which is scarce in that
    country.

    Assumptions:
    Two countries, two commodities and two factor
    Transportation costs not considered
    2. Human Critical Approach/ Skills Theory of
    International Trade

    Becker, Kennen and Kessing


    Level of skill determines export success
    Varying levels of skill
    3. Natural Resources Theory ( J. Vauek)

    A country will export those products in which it enjoys


    natural advantage and import those products where it
    faces natural scarcity
    4. Scale Economies

    There is a direct relationship between the size of the


    domestic market, average unit cost of production and
    success in overseas markets by being able to compete
    well with other competitors.

    Benefit of large scale production: lower costs of


    production and easy export entry
    5. Theory of Product Life Cycle ( Raymond Vernon)
    IPLC
    Introduction:
     Life cycle starts with the location from where the
    product originates.
     Innovation which is a result of R&D
     Initially the products are marketed within the
    country and gradually shifted to overseas
    markets.
    Growth

    Huge revenue is generated by increasing exports to


    many countries
    The export firm becomes capital intensive
    Expansion of business
    Establishment of manufacturing units
    Maturity stage
    Product is already well known
    Quality of the product becomes the deciding factor
    Inevitable price war and stiff competition
    Brand equity and repeat orders
    Setting up of manufacturing units in areas where the
    production cost per unit is low

    Cost cutting becomes important


    Decline

    Maximum production takes place in less developed


    countries
    Business operations with low margin of profits
    Company in the innovating country starts working on
    a completely new product
    The basis for international trade
    Knowledge of foreign exchange
    Government rules and regulations
    PEEST factors
    Emergence of Trading Blocs
    WTO
    “ Divergent scarcities of factors are the moving forces
    behind International Trade. This makes countries
    dependent on one another resulting into International
    trade.”

    source:
    Essays in Economic Analysis- A. P. Lerner pg 68.

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