Overview trade theories Classical trade theories Explanation International Economics Absolute advantage theory (Smith) * When one nation is more efficient than another in the production of one commodity but is less efficient than the other nation in producing a second commodity, then both nations can gain by each specializing in the production of the commodity of its absolute advantage (most efficient commodity) and exchanging part of its output with the other nation for the commodity of its absolute disadvantage (least efficient commodity).
Comparative advantage theory (Richard) According to the law of comparative advantage, even if one nation is less efficient than (has an absolute disadvantage with respect to) the other nation in the production of both commodity one and two, there is still a basis for mutually beneficial trade. The first nation should specialize in the production of and export the commodity in which its absolute disadvantage is the smallest (=commodity of its comparative advantage) and import the commodity in which its absolute disadvantage is greater (=comparative disadvantage).
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Shortcomings Classical trade theories ) Labor theory of value Arcadian theory of international trade assumes the application of labor theory of value (amount of labor going into the production determines the value or price of a commodity) 0 not able to use since the labor theory itself is based upon unrealistic assumptions: for it to be valid, labor should be homogeneous, labor should be the only factor of production, or its proportionate share in total costs should be equal in all products. ) Cost differences Classical theories do not explain the causes of differences in efficiency of productive sources, hence it is unable to explain the phenomenon of changes in productive efficiency of an economy 0 nowadays, there are many factors (technological, educational, institutional, political, quality of governance, economic incentives etc) that can cause a difference in the efficiency of productive resources. ) Competitive markets Classical theories assume that trading countries have competitive markets, however this is not so 0 modern economies are characterizes by a mixture of the features of competitive and non-competitive markets (free trade trend, economic groupings). 4) Factor endowment, technology and constant returns Classical theories do not represent the working of ever-changing and growing economies 0 differences in resource endowments of different countries can themselves be the cause of international trade. ) Economies of scale Arcadian theory ignores the possibility that even nations endowed with similar Overview Trade Theories International Economics For Merge By Santayana the quantity of a good produced, the lower the per-unit fixed cost because they are shared over a large number of goods) and they take advantage of that 0 each country reducing large quantities of selected goods. Contemporary (new) trade theories Hecklers-Olin Theory/ Factor endowment theory (Hecklers and Olin) * A country’s relative endowments of land, labor and capital will determine the relative costs of these factors. These factor costs, in turn, will determine which goods the country can produce most efficiently. Rule: a country will export the commodity whose production is intensive of the factor (labor, land, capital) in which the county is relatively abundant * Limonite Paradox: Studies by Limonite revealed that US actually sports labor intensive goods and imports capital-intensive products (even though AC. To Hecklers-Olin theory, USA was abundant in capital): Hecklers-Olin theory not supported by the evidence!
Specific Factors Model (Vine) * This theory analyses the distribution of income resulting from free trade, when factors are specific to a sector. This implies that the factor is immobile even across industries within a country. * When trade is opened and one country has a comparative advantage in computers, more labor will move to the computer industry and less to the steel industry, so that as more computers are produces, prices of computers go up more than the wage costs, so that incomes of computer capital owners will increase (reverse happens in steel industry).
Example: Labor can move between computer and steel industries, but capital cannot (steel capital cannot be used in computer industry and vice-versa). International Product Life Cycle Theory (Vernon) * Many manufactured products will be produced first in the countries in which they were researched and developed (mostly industrialized countries). Over the product’s fife cycle, production will tend to become more labor-intensive and will be shifted to foreign locations. This model by Vernon relaxes assumptions about same technology 0 now countries have different technologies.
Speed of product life cycle depends on technology and ease to produce! * There exist 4 stages in the life off product 1) Introduction: manufactured good is introduced in the home market (high price) 2) Growth: Domestic industry shows export strength. 3) Maturity 4) Decline (lower price) Country similarity theory (Lender) = Spill-over theory of trade = Theory of overlapping demand Lender advanced the hypothesis that a country exports those manufactured goods for which there is a broad local market.
He assumed that when exports grow out of domestic production, I. E. The domestic market is saturated, producers try to expand by beginning to sell the product in other markets abroad. * His theory is also known as “Countries similarity theory’ assuming that countries with similar income levels and standards of living will consume similar types of goods. Hence, rich countries relaxes the classical assumptions which emphasized country differences based on trial advantage.