BASIS OF INTERNATIONAL

TRADE

Ms. Kanupriya
PGGC-11, Chandigarh
CONTENTS

INTRODUCTION
BASIS OF INTERNATIONAL TRADE
1. Theory of absolute cost advantage
2. Theory of comparative cost advantage
3. Factor endowment theory
4. Theory of competitive advantage
5. Product life cycle theory
6. Theory of identical preferences
7. Product differentiation
8. Outlet for domestic surplus
CONCLUSION
INTRODUCTION
The reason for the emergence of
international trade is that the human wants
are varied and unlimited and no single
country possesses the adequate resources
to satisfy all these wants. Hence there
arises a need for interdependence between
countries in the form of international trade.
So in order to make effective utilisation of
the world’s resources international trade is
to be boosted and the problems faced by
the countries should be dealt with.
BASIS OF INTERNATIONAL
TRADE
No country is self sufficient in producing all
the required goods and services from its
own resources. This problem can be
solved through international trade where
the countries obtain those goods which it
cannot produce or cannot produce as
cheaply as possible in another country.
However this is not the only basis for doing
international trade, there are other reasons
also. Trade economists have laid down
different theories for international trade.
Contd….
Theory of absolute cost advantage
Theory of comparative cost advantage
Factor endowment theory
Theory of competitive advantage
Product life cycle theory
Theory of identical preferences
Product differentiation
Outlet for domestic surplus
THEORY OF ABSOLUTE COST
ADVANTAGE (By Adam Smith)
Producing a good with fewer inputs (capital,
labor, land, raw materials, etc.) per unit of
output than other countries
If input prices are the same in two
countries, the country with an absolute
advantage in a good will have a lower unit
cost of production for that good
A country should produce and export
products in which it has an absolute
advantage
A country should import products in which it
has an absolute disadvantage
Per unit cost of production( Rs.)

Country Cotton Tea India has

absolute cost
advantage in the
India 5 10 production of
cotton and
Indonesia in the
production of tea
Both countries
will gain if India
Indonesia 10 5 produces and
exports cotton
and Indonesia
produces and
exports tea.
THEORY OF COMPARATIVE COST
ADVANTAGE (By David Ricardo)
Focus on comparative cost advantage not
on absolute cost advantage.
Each country specialises in the production
of that commodity in which its comparative
cost of production is the least.
A country will export those commodities in
which its comparative costs are less.
A country will import those commodities in
which its comparative costs are high.
 Commodities (Per unit cost of
production)

Country Y has
A B C D E comparative
Country

advantage in products
B and C
X 10 12 13 14 15
Country Y will put all
its resources in the
production of B and C
Y 9 5 8 13 14
Country X will produce
other products i.e. A,
Cost 1 7 5 1 1 D, and E.
Difference
FACTOR ENDOWMENT THEORY
(By Heckscher and Ohlin)
A country that is relatively abundant in a factor
of production should export goods that use a lot
of that factor in the production process, and
import other goods

Example: a country like China with a lot of

labour should export labour-intensive goods

Why? If a factor is relatively abundant, it will be

relatively cheap, and a country will be more
globally competitive in products that use a lot of
that factor
THEORY OF COMPETITIVE
ADVANTAGE (By Micheal Porter)
To compete in the world a country
requires a strategy to gain a
competitive edge over the others.
Competitive advantage is created by
technological and institutional change,
not just inherited from a country’s
natural endowments.
PRODUCT LIFE CYCLE THEORY
(By Vernon)
Industrialised countries contribute more
resources to research and development
which results in development of new
products
In early stage they have monopoly on such
new products and enjoy easy access to
foreign markets
Later other countries start imitating their
products and initial advantage disappears.
THEORY OF IDENTICAL
PREFERENCES (By Linder)
Based on the principle that trade
opportunities are more among
countries at similar stage of
development with similar demand
structure
E.g. USA and Japan are largest trade
partners because of identical
consumer preferences and similar
stage of development.
PRODUCT DIFFERENTIATION

Another reason or basis for

international trade can be the product
differentiation.
It means differentiating a product in
some manner such as adding
different and new features in the
same basic products.
OUTLET FOR SURPLUS
Most countries involve in international trade
because they have surplus production
Surplus commodities or some unused
resources can be exported
E.g. India had surplus wheat in 2000 and
there was no additional storage capacity,
so it was decided to export wheat at
cheaper rates in the international market.
CONCLUSION

To sum it up, we can say that there

are multiple basis for international
trade. It can also be said that these
are the inevitable factors which force
a country to do international trade.
THANK

YOU