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Adam Smith claimed that a country should specialise in, and export, commodities in which it had
an absolute advantage.An absolute advantage existed when the country could produce a
commodity with less costs per unit produced than could its trading partnerBy the same
reasoning, it should import commodities in which it had an absolute disadvantage.

While there are possible gains from trade with absolute advantage, comparative advantage
extends the range of possible mutually beneficial exchanges. In other words it is not necessary to
have an absolute advantage to gain from trade, only a comparative advantage.

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David Ricardo argued that a country does not need to have an absolute advantage in the
production of any commodity for international trade between it and another country to be
mutually beneficial. Absolute advantage meant greater efficiency in production, or the use of less
labor factor in production Two countries could both benefit from trade if each had a relative
advantage in production. Relative advantage simply meant that the ratio of the labor embodied in
the two commodities differed between two countries, such that each country would have at least
one commodity

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The gravity model of trade in international economics, similar to other gravity models in social
science, predicts bilateral trade flows based on the economic sizes of (often using GDP
measurements) and distance between two units. The basic theoretical model for trade between
two countries takes the form of:

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The model has also been used in international relations to evaluate the impact of treaties and
alliances on trade, and it has been used to test the effectiveness of trade agreements and
organizations such as the North American Free Trade Agreement (NAFTA) and the World Trade
Organization (WTO).

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The Heckscher-Ohlin model (H-O model), also known as the v
 

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a general equilibrium mathematical model of international trade, developed by Eli Heckscher
and Bertil Ohlin at the Stockholm School of Economics. It builds on David Ricardo's theory of
comparative advantage by predicting patterns of commerce and production based on the factor
endowments of a trading region. The model essentially says that countries will export products
that utilize their abundant and cheap factor(s) of production and import products that utilize the
countries' scarce factor(s).[6]

The results of this work has been the formulation of certain named conclusions arising from the
assumptions inherent in the model. These are known as:

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eontief's paradox in economics is that the country with the world's highest capital-per worker
has a  capital:labour ratio in exports than in imports.

This econometric find was the result of Professor Wassily W. eontief's attempt to test the
Heckscher-Ohlin theory empirically. In 1954, eontief found that the U.S. (the most capital-
abundant country in the world by any criteria) exported labor-intensive commodities and
imported capital-intensive commodities, in contradiction with Heckscher-Ohlin theory.

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The inder hypothesis (demand-structure hypothesis) is a conjecture in economics about

international trade patterns. The hypothesis is that the more similar are the demand structures of
countries the more they will trade with one another. Further, international trade will still occur
between two countries having identical preferences and factor endowments (relying on
specialization to create a comparative advantage in the production of differentiated goods
between the two nations).

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ocation theory is concerned with the geographic location of economic activity; it has become an
integral part of economic geography, regional science, and spatial economics. ocation theory
addresses the questions of what economic activities are located where and why. ocation theory
rests ² like microeconomic theory generally ² on the assumption that agents act in their own
self interest. Thus firms choose locations that maximize their profits and individuals choose
locations, that maximize their utility.

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In economics, a market failure is a situation wherein the allocation of production or use of goods
and services by the free market is not efficient. Market failures can be viewed as scenarios where
individuals' pursuit of pure self-interest leads to results that can be improved upon from the
societal point-of-view. The first known use of the term by economists was in 1958, but the
concept has been traced back to the Victorian philosopher Henry Sidgwick

Market imperfection can be defined as anything that interferes with trade. This includes two
dimensions of imperfections. First, imperfections cause a rational market participant to deviate
from holding the market portfolio.Second, imperfections cause a rational market participant to
deviate from his preferred risk level.Market imperfections generate costs which interfere with
trades that rational individuals make (or would make in the absence of the imperfection).

The idea that MNEs owe their existence to market imperfections was first put forward by Hymer,
Kindleberger and Caves.The market imperfections they had in mind were, however, 

imperfections in markets for final products.

According to Hymer, market imperfections are structural, arising from structural deviations from
perfect competition in the final product market due to exclusive and permanent control of
proprietary technology, privileged access to inputs, scale economies, control of distribution
systems, and product differentation, but in their absence markets are perfectly efficient