Theories of Trade

HOW WE ARE MOVING FROM ONE THEORY TO ANOTHER THEORY?

Classical( LATE 18TH CENTUARY AND
MID OF 19TH Centuary)
• Adam Smith: Absolute Advantage
2 COUNTRIES HAVE ABSOLUTE ADVANTAGE IN VARIOUS COMMODITIES
if a country has not any abs. advantage, then ?
• Ricardo: Comparative Advantage
2*2 TWO COUNTRIES AND TWO COMMODITIES
LABOUR THEORY OF VALUE
why one factor ?
 Neo- Classical
• Heckscher- Ohlin : Factor Abundance Theory(2*2*2)(1919 AND 1933)
What is the reason of varying advantages ?
different in factor endowments
A capital-abundant country will export the capital-intensive good, while
the labor-abundant country will export the labor-intensive good
• Haberler: Opportunity Cost(1936)
Comparative cost in terms of opportunity cost
 Why ? encylopedia
• Factor price equalization is an economic theory, by Paul A. Samuelson (1948), which
states that the prices of identical factors of production, such as the wage rate, or the
rent of capital, will be equalized across countries as a result of international trade in
commodities. The theorem assumes that there are two goods and two factors of
production, for example capital and labour. Other key assumptions of the theorem
are that each country faces the same commodity prices, because of free trade in
commodities, uses the same technology for production, and produces both goods.
Crucially these assumptions result in factor prices being equalized across countries
without the need for factor mobility, such as migration of labor or capital flows.
• A simple summary of this theory is when the prices of the output goods are
equalized between countries as they move to free trade, then the prices of the
factors (capital and labor) will also be equalized between countries.
 why?
• Stolper Samuelson Theorem 1941
“a rise in the relative price of a good will lead to a rise in the real return
to that factor which is used most intensively in the production of the
good, and conversely, to a fall in the real return to the other factor”
• factor price equalization theorem shows that
• Factor prices will be equalized across the nations.
• Given , commodity prices are equal, technology constant….
• Px/Py= w/r….. Under free trade
• safta: south asia free trade agreement( a,b, b, m, n, p, s, I )
• tariff : to curtail imports
• creation diversion
free trade
• India
• NEPAL
• the commodity prices are same in both counries
• Factor prices will also be same
•
 Commodity price’ impact on factor prices
• commodity price increase
• Px/Py increase x Is labour intensive commodity and y IScapital
intensive commodity
• X – Labour returns of labour will increase , while returns of capital
will decrease
• Classical -------- Neo Classical ----- STOLPER SAMUELSON
THEOREM----- FACTOR PRICE EQUALISATION