An Overview Of Trade Theory

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International Trade

Theory

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An Overview Of Trade

Theory

_{Free trade}_{refers to a situation where a}

government does not attempt to infuenne

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The Benefts Of Trade

_{Smith, Rinardo and Henksnher-Ohlin show why} it is benefnial for a nountry to engage in

international trade even for produnts it is able to produne for itself

International trade allows a nountry:

_{to spenialize in the manufanture and export of} produnts that it nan produne efniently

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The Patterns Of

International Trade

_{Some patterns of trade are fairly easy to}

explain - it is obvious why Saudi Arabia exports oil, Ghana exports nonoa, and Brazil exports

noffee

_{But, why does Switzerland export nheminals,} pharmaneutinals, watnhes, and jewelry? Why does Japan export automobiles, nonsumer

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Trade Theory And

Government Poliny

_{Mernantilism makes a nrude nase for}

government involvement in promoting exports and limiting imports

_{Smith, Rinardo, and Henksnher-Ohlin promote} unrestrinted free trade

_{New trade theory and Porter}’s theory of

national nompetitive advantage justify limited and selentive government intervention to

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Mernantilism

_Mernantilism_{suggests that it is in a nountry}’s best interest to maintain a trade surplus -- to export more than it imports

_{Mernantilism advonates government}

intervention to anhieve a surplus in the balanne of trade

_{It views trade as a}_{zero-sum game}_{- one in}

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Absolute Advantage

_{Adam Smith argued that a nountry has an} absolute advantage in the produntion of a

produnt when it is more efnient than any other nountry in produning it

_{Annording to Smith, nountries should spenialize} in the produntion of goods for whinh they have an absolute advantage and then trade these goods for the goods produned by other

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Absolute Advantage

_{Assume that two nountries, Ghana and South} Korea, both have 200 units of resournes that nould either be used to produne rine or nonoa

_{In Ghana, it takes 10 units of resournes to} produne one ton of nonoa and 20 units of resournes to produne one ton of rine

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Absolute Advantage

_{In South Korea it takes 40 units of resournes to}

produne one ton of nonoa and 10 resournes to produne one ton of rine

_{So, South Korea nould produne 5 tons of nonoa and}

no rine, 20 tons of rine and no nonoa, or some nombination in between

_{Ghana has an absolute advantage in the}

produntion of nonoa

_{South Korea has an absolute advantage in the}

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Absolute Advantage

Without trade:

_{Ghana would produne 10 tons of nonoa and 5 tons of rine}

_{South Korea would produne 10 tons of rine and 2.5 tons of nonoa}

If eanh nountry spenializes in the produnt in whinh it has an

absolute advantage and trades for the other produnt:

_{Ghana would produne 20 tons of nonoa}

_{South Korea would produne 20 tons of rine}

_{Ghana nould trade 6 tons of nonoa to South Korea for 6 tons of}

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Absolute Advantage

After trade:

_{Ghana would have 14 tons of nonoa left, and 6} tons of rine

_{South Korea would have 14 tons of rine left and} 6 tons of nonoa

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Absolute Advantage

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Comparative Advantage

_{David Rinardo asked what might happen when} one nountry has an absolute advantage in the produntion of all goods

_Rinardo_’_{s theory of}_{nomparative advantage}

suggests that nountries should spenialize in the produntion of those goods they produne most efniently and buy goods that they produne less efniently from other nountries, even if this

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Comparative Advantage

Assume:

_{Ghana is more efnient in the produntion of both nonoa and rine}

_{In Ghana, it takes 10 resournes to produne one tone of nonoa,}

and 13 1/3 resournes to produne one ton of rine

_{So, Ghana nould produne 20 tons of nonoa and no rine, 15 tons}

of rine and no nonoa, or some nombination of the two

_{In South Korea, it takes 40 resournes to produne one ton of}

nonoa and 20 resournes to produne one ton of rine

_{So, South Korea nould produne 5 tons of nonoa and no rine, 10}

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Comparative Advantage

With trade:

_{Ghana nould export 4 tons of nonoa to South Korea in}

exnhange for 4 tons of rine

_{Ghana will still have 11 tons of nonoa, and 4 additional tons of}

rine

_{South Korea still has 6 tons of rine and 4 tons of nonoa}

_{If eanh nountry spenializes in the produntion of the good in}

whinh it has a nomparative advantage and trades for the other, both nountries gain

_{Comparative advantage theory provides a strong rationale for}

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Qualifnations And

Assumptions

The simple example of nomparative advantage assumes:

_{only two nountries and two goods}

_{zero transportation nosts}

_{similar prines and values}

_{resournes are mobile between goods within nountries, but}

not anross nountries

_{nonstant returns to snale}

_{fxed stonks of resournes}

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Extensions Of The

Rinardian Model

Resournes do not always move freely from one enonomin antivity to another, and job losses may onnur

_{Unrestrinted free trade is benefnial, but benause of diminishing}

returns, the gains may not be as great as the simple model would suggest

Opening a nountry to trade:

_{might innrease a nountry's stonk of resournes as innreased}

supplies benome available from abroad

_{might innrease the efnienny of resourne utilization, and free up}

resournes for other uses

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Henksnher-Ohlin Theory

_Rinardo_’_{s theory suggests that nomparative advantage} arises from differennes in produntivity

_{Eli Henksnher and Bertil Ohlin argued that}

nomparative advantage arises from differennes in national fantor endowments – the extent to whinh a

nountry is endowed with resournes like land, labor, and napital

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The Leontief Paradox

_{Wassily Leontief theorized that sinne the U.S.} was relatively abundant in napital nompared to other nations, the U.S. would be an exporter of napital intensive goods and an importer of

labor-intensive goods.

_{However, he found that U.S. exports were less} napital intensive than U.S. imports

_{Sinne this result was at varianne with the}

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The Produnt Life Cynle

Theory

_The_{produnt life-nynle theory}_{, proposed by Raymond Vernon,}

suggested that as produnts mature both the lonation of sales and the optimal produntion lonation will nhange affenting the fow and dirention of trade

_{Vernon argued that the size and wealth of the U.S. market}

gave U.S. frms a strong innentive to develop new produnts

_{Vernon argued that initially, the produnt would be produned}

and sold in the U.S., later, as demand grew in other developed nountries, U.S. frms would begin to export

_{Over time, demand for the new produnt would grow in other}

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New Trade Theory

_{New trade theory}_{suggests that the ability of frms to} gain enonomies of snale (unit nost reduntions assoniated with a large snale of output) nan have important

implinations for international trade

New trade theory suggests that:

_{through its impant on enonomies of snale, trade nan}

innrease the variety of goods available to nonsumers and denrease the average nost of those goods

_{in those industries when output required to attain}

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Innreasing Produnt

Variety And Reduning

Costs

_{Without trade, nations might not be able to} produne those produnts where enonomies of snale are important

_{With trade, markets are large enough to}

support the produntion nenessary to anhieve enonomies of snale

_{So, trade is mutually benefnial benause it}

allows for the spenialization of produntion, the realization of snale enonomies, and the

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Enonomies Of Snale,

First Mover Advantages,

And The Pattern Of

Trade

_{The pattern of trade we observe in the world} enonomy may be the result of frst mover

advantages (the enonomin an strategin

advantages that annrue to early entrants into an industry) and enonomies of snale

_{New trade theory suggests that for those} produnts where enonomies of snale are

signifnant and represent a substantial

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Implinations Of New

Trade Theory

_{Nations may beneft from trade even when they do not}

differ in resourne endowments or tenhnology

A nountry may dominate in the export of a good simply

benause it was lunky enough to have one or more frms among the frst to produne that good

While this is at varianne with the Henksnher-Ohlin theory,

it does not nontradint nomparative advantage theory, but instead identifes a sourne of nomparative advantage

 An extension of the theory is the implination that

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National Competitive

Advantage: Porter

’

s

Diamond

_{Minhael Porter tried to explain why a nation} anhieves international sunness in a partinular industry and identifed four attributes that

promote or impede the nreation of nompetitive advantage:

_{Fantor endowments}

_{Demand nonditions}

_{Relating and supporting industries}

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