TRADE THEORIES

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WHY IS INTERNATIONAL TRADE IMPORTANT?

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PRIMARY ECONOMIC OBJECTIVE OF NATION HIGH STANDARD OF LIVINGHIGH PRODUCTIVITYHIGH INCOME HIGH LEISURE. INTERNATIONAL TRADERESOURCES CHANNELED FROM LOW-PRODUCTIVITY USES TO HIGH PRODUCTIVITY. BOTH IMPORTS AND EXPORTS ARE NECESSARY FOR RISING PRODUCTIVITY

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THE BASIS OF INTERNATIONAL TRADE IS THE GAINS OR PROFITS TO BE MADE FROM EXCHANGE OF GOODS AND SERVICES. PRICES DIFFERENT DEMAND AND SUPPLY TASTE PATTERNS AND COST PATTERNS THERE PRICE DIFFERENTIALS AS MOST REASON FOR TRADE.

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HOW INTERNAL TRADE DIFFERENT THAN INTERNATIONAL TRADE?

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CONT.
FACTOR MOBILITY PRODUCT MOBILITY ECONOMIC ENVIRONMENT MONETARY UNITS

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WHY NATIONS TRADE: ABSOLUTE ADVANTAGE?

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ADAM SMITH - ADVOCATED FREE TRADE -PROMOTING INTERNATIONAL DIVISION OF LABOUR

FREE TRADE CONCENTRATE UPON PRODUCE CHEAPLY-WITH BENEFITS OF DIVISION OF LABOUR. BASIS OF TRADE IS COST DIFFERENCE. PRODUCTIVITIES OF FACTOR INPUTS DIFFER HENCE PRODUCTION COST. DIFFERENCE IN PRODUCTIVITIES IN NATURAL AND ACQUIRED.

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SMITHS CONCEPT OF COST WAS FOUNDED UPON THE LABOUR THEORY OF VALUE, WHICH ASSUMES THAT WITH EACH NATION.
(1)

LABOUR IS THE ONLY MEANS OF PRODUCTION AND IS HOMOGENOUS (OF ONE QUALITY).

(2)THE COST OR PRICE OF A GOOD DEPENDS EXCLUSIVELY UPON THE AMOUNT OF LABOUR REQUIRED TO PRODUCE IT.

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SMITHs TRADING PRINCIPLE WAS THE PRINCIPLE OF ABSOLUTE ADVANTAGE: ASSUMPTIONS TWO NATION, TWO PRODUCT WORLD AND ONE MEANS OF PRODUCTION. DEFINITION : THE COMMODITY WILL BE PRODUCED WHERE THE RESOURCE INPUTS ARE ABSOLUTELY LOWEST. THE ADVANTAGE OF INTERNATIONAL TRADE, THEN LIES IN PURCHASING COMMODITIES CHEAPER ABROAD THAN AT HOME

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 INTERNATIONAL TRADE AND SPECIALISATION WILL BE BENEFICIAL WHEN ONE

NATION HAS AN ABSOLUTE COST ADVANTAGE (THAT IS, USES LESS LABOUR TO PRODUCE A UNIT OF OUTPUT) IN ONE GOOD AND THE OTHER NATION HAS AN ABSOLUTE COST ADVANTAGE IN THE OTHER GOOD. A NATION WILL IMPORT THOSE GOODS IN WHICH IT HAS AN ABSOLUTE COST DISADVANTAGE; IT WILL EXPORT THOSE GOODS IN WHICH IT HAS AN ABSOLUTE COST ADVANTAGE.

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Absolute cost advantage

INTERNATIONAL DIVISION OF LABOUR AND INTERNATIONAL TRADE, WHICH ENABLE EVERY COUNTRY TO SPECIALISE AND TO EXPORT THOSE THINGS WHICH IT CAN PRODUCE CHEAPER IN EXCHANGE OF WHAT OTHERS CAN PROVIDE AT A LOWERCOST HAVE BEEN AND STILL ONE OF THE BASIC FACTORS PROMOTING ECONOMIC WELL BEING AND INCREASING NATIONAL INCOME OF EVERY PARTICIPATING COUNTRIES.
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WHY NATIONS TRADE: COMPARATIVE ADVANTAGE ?

The doctrine of comparative costs maintains that if trade is left free, each country in the long run, tends to specialise in the production and export of those commodities it enjoys a comparative advantage in terms of real costs and to obtain by importation of those commodities which would be produced at home at a comparative disadvantage in terms of real costs, and that such specialisation is to mutual advantage of to edit Masterparticipating in it. Click countries subtitle style

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ricardo (1772-1823) developed a principle to show that how mutually beneficial trade can occur even when both the nation is absolutely more efficient(least cost producer) than its trading partner in the production of all goods.

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assumptions
The world consist of two nations, each using a single input to produce two commodities.

Labour is the only input and labour is homogenous and fully employed.

Labour Click tofreely move among industries within the can edit Master subtitle style nation, but is incapable of moving between nations.

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Cont.
Level of technology is fixed for both nations. Different nations may use different technologies, but all firms within each nation utilize a common production method.

PERFECT COMPETITION, FREE TRADE, TRANSPORTATION COST ZERO, NO GOVERNMENT BARRIERS TO TRADE.

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Cont

Ricardo thought that comparative advantage depended on comparative differences in labour that is technology. He did not explain the basis for these differences.

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FACTOR ENDOWMENT THEORY

IN THE 1920S AND 1930S, THE SWEDISH ECONOMISTS ELI HECKSCHER AND BERTIL OHLIN FORMULATED A THEORY ADDRESSING TWO QUESTION LEFT LARGELY UNEXPLAINED BY RICARDO.

(1) what determines comparative advantage? (2) What effect does international trade have on the earnings of various factors of production ( distribution of income)
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The

factor

endownment

theory

states

that

comparative advantage is explained exclusively by differences in relative national supply conditions. In particular, the theory highlights the role capital) of nations resource endownments ( such as labour and

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According to the factor endownment theory, relative price levels differ among nations because (1) The nations have different relative endownments of factor inputs and (2) different commodities require that the factor inputs be used with differing intensities in their production. () Given these circumstances a nation will export that commodity for which a large amount of the relatively abundant (cheap) input is used.

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Cont

The capital abundant country thus exports the capital intensive product, and the land abundant

country exports the land intensive product.

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Trade and the distribution of income

The factor-endowment theory states that the export of commodities embodying large amounts of the relatively cheap, abundant factors makes those factors less abundant in the domestic market. The increased demand for the abundant factor leads to an increase in its return.

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Cont
At the same time returns to the factor used intensively in the import-competing product (the scarce factor) decrease as its demand falls. The increase in the returns to each countrys abundant factor thus comes at the expense of the scarce factors returns

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THE LEONTIEFF PARADOX

FIRST

ATTEMPTS

TO

TEST

THE

H-O

MODEL WAS DONE WASSILY LEONTIEFF IN 1954, USING INPUT-OUTPUT TABLES FOR THE UNITED STATES. LEONTIEFF MEASURED THE FACTOR INTENSITIES OF EXPORTS AND IMPORT REPLACEMENTS. LEONTIEFFS U.S.IMPORTS
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RESULTS WERE

SHOWED MORE

THAT

CAPITAL

POSSIBLE

EXPLAINATIONS

TRADING PATTERNS WOULD BE DISTORTED BY SECOND WORLD WAR AND PROTECTIONIST POLICIES. USE OF IMPORT REPLACEMENTS AS A PROXY FOR IMPORTS. US HIGH PERCAPITA INCOME AND HIGHER PREFERENCE FOR CAPITAL INTENSIVE GOODS. US LABOUR WAS SUPERIOR TO THAT OF OTHER COUNTRIES.
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CONT

LEONTIEFF

FAILED

TO

DISTINGUISH

HUMAN CAPITAL AND PHYSICAL CAPITAL.

NEXT

EXPLAINATION

REFERES

TO

NATURAL RESOURCES. IN ALL POSSIBILITY IN US DUE TO RAPID INDUSTRIALISATION RESOURCE WAS A SCARCE COMMODITY AND
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IT

WAS

LABOUR

AND

CAPITAL

ABUNDANT, HENCE THE EXPORTS WOULD

CHAN CE

FIRM STRATE GY, RIVALRY

FACTOR CONDITI ONS Click to edit Master subtitle style

DEMAND CONDITIONS

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RELATED SUPPORTING INDUSTRIES

GOVE RNME

MICHAEL PORTER: THE COMPETITIVE ADVANTAGE OF NATIONS COMPETITIVE THE THEORY OF

ADVANTAGE CONCENTRATES ON A FIRMS HOME-COUNTRY ENVIRONMENT AS THE MAIN SOURCE OF COMPETENCIES AND INNOVATIONS. OPERATING RESULTS SUCH AS SALES AND PROFITS ARE MEASURES THAT DEPEND ON THE LEVEL OF PSYCHOLOGICAL VALUE CREATED FOR CUSTOMERS. THE GREATER THE PERCEIVED CONSUMER VALUE, THE STRONGER THE 5/17/12

CONT..

VALUE IS LIKE A BEAUTY-IT IS THE EYE OF THE BEHOLDER. IN SUM , COMPETATIVE ADVANTAGE IS ACHIEVED BY CREATING MORE VALUE THAN THE COMPETITION, AND VALUE IS DEFINED BY CUSTOMER PERCEPTION. FACTOR CONDITIONS: THE ENDOWNMENT OF RESOURCES HAVE BEEN DIVIDED INTO FIVE CATEGORIES: HUMAN, PHYSICAL, KNOWLEDGE, CAPITAL AND INFRASTRUCTURE.
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CONT

(A)Human resources: skills and wage levels. (B) Physical resources: availability, quantity, quality and cost of land, water, minerals and other natural resources. (C)Knowledge resources (D)Capital resource (E) Infrastructure Resource

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EXAMPLES.

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DEMAND CONDITIONS
THREE CHARACTERISTICS OF HOME DEMAND ARE PARTICULARY IMPORTANT TO THE CREATION OF COMPETITITVE ADVANTAGE (A) THE COMPOSITION OF HOME DEMAND (B) THE SIZE AND PATTERN OF GROWTH OF HOME DEMAND (C) THE MEANS BY WHICH A NATIONS HOME DEMAND PULLS THE NATIONS PRODUCTS AND SERVICES INTO FOREIGN MARKETS

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EXAMPLES..

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INTERNATIONALLY COMPETATIVE SUPPLIERS INDUSTRIES PROVIDE INPUTS TO DOWN STREAM INDUSTRIES THAT ARE LIKELY TO BE INTERNATIONALLY COMPETITIVE IN TERMS OF TECHNOLOGICAL INNOVATION, PRICE, AND QUALITY . IT IS THE CONTACT AND COORDINATION THAT ALLOWS THE OPPORTUNITY TO STRUCTURE THE VALUE CHAIN AND LINKAGES WITH SUPPLIERS ARE
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RELATED AND SUPPORTING INDUSTRIES

FIRM STRATEGY, STRUCTURE AND RIVALRY

DIFFERENCES IN MANAGEMENT STYLES, ORGANISATIONAL SKILLS AND STRATEGIC PERSPECTIVES CREATE ADVANTAGES AND DISADVANTAGES FOR FIRMS COMPETING IN DIFFERENT TYPES OF INDUSTRIES AS DO DIFFERENCES IN THE INTENSITY OF DOMESTIC RIVALRY.

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OTHER FORCES ACTING ON THE DIAMOND

CHANCE: EVENTS THAT ARE BEYOND THE CONTROL OF FIRMS, INDUSTRIES AND USUSALLY GOVERNMENTS . THEY CREATE MAJOR DISCONTINUITIES IN TECHNOLOGIES THAT ALLOW NATIONS AND FIRMS THAT WERE NOT COMPETITITVE TO LEAPFROG OVER OLD COMPETITIORS AND BECOME COMPETITIVE-EVEN LEADERS-IN THE CHANGED INDUSTRY .

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GOVERNMENT

GOVERNMENT INFLUENCES DETERMINANT BY VIRTUE OF ITS ROLE AS A BUYER OF PRODUCTS AND SERVICES AND BY ITS ROLE AS A MAKER OF POLICIES ON LABOUR, EDUCATION, CAPITAL FORMATION, NATURAL RESOURCES AND PRODUCT STANDARDS.

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OTHER NONMARKET FACTORS

THE NONMARKET FORCES INCLUDE, IN ADDITION TO GOVERNMENT, INTEREST GROUPS, ACTIVISTS, AND THE PUBLIC. THEE NON MARKET FORCES ARE PART OF A NONECONOMIC STRATEGY SYSTEM THAT OPERATES ON THE BASIS OF SOCIAL, POLITICAL AND LEGAL FORCES THA TINTERACT IN THE NONMARKET ENVIRONMENT OF THE FIRM.
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