Classical Theories of International Trade

proportion Trade
International Product Cycle
New Trade Theory
National Competitive Advantage

commodity cheaper than we ourselves can make it, better buy

it of them with some part of the product of our own industry, employed in a way in which we have some advantage”
Wealth of Nations, Adam Smith

1776, Adam Smith published the first modern statement of economic

theory, An Inquiry into the Nature and Causes of the Wealth of Nations
The Wealth of Nations attacked mercantilism—the system of which dominated economic thought in the 1700s
Smith proved wrong the belief that trade was a zero sum game—that the gain of one nation from trade was the loss of another
On the other hand… Voluntary exchange (trade) is a positive sum game —both nations can gain

one country to produce more of a product with the

same amount of input than another country
(same thing) The ability of a country to produce a good using fewer resources than another country (lower opportunity cost)

goods where it is most efficient …. and trade for

those goods where it is not efficient

Trade between countries is, therefore, beneficial

are gains to be had by both countries party to

an exchange

… questions the objective of national governments to acquire “wealth”: through restrictive trade policies

… also measures a nation’s wealth by the living standards of its people

products are produced, machines and cloth
Labor is fixed, homogeneous within

a country, the only factor of production, and is fully utilized
Technology and production costs are constant
Transportation costs are zero and the countries barter (trade) for goods

TRADE BASED ON ABSOLUTE ADVANTAGE

various combinations of two goods that a country can produce

when all of a country’s resources are fully employed and used in their most efficient manner

THE PRODUCTION POSSIBILITIES FRONTIER AND CONSTANT COSTS

2 4
0 5
India - Opportunity Costs

Machine = 7.5

cloth
Cloth = 0.133 machine

EU - Opportunity Costs

Machine = 2 cloth
Cloth = 0.5 machine

“Opportunity Cost” also known as “Relative Price”

= Opportunity Cost of Machines
Same graph, drawn more to scale!
EU:

Slope = Opportunity Cost = -0.5

India: Slope = Opportunity Cost = -0.133

an absolute advantage in machine production

Indian workers are more productive

in producing cloth
India has an absolute advantage in cloth production

Absolute Advantage: Production Conditions When Each Country Is More Efficient in the Production of One Commodity

argued:

A country should produce only goods where it is most

efficient, and trade for those goods where it is not efficient

be fully produced
(and)
(and)
(and)
This is a condition under Autarky: (The complete

absence of trade)

Under Autarky all nations can only consume the goods they produce at home

be fully produced
(and)
(and)
(and)
(and)
However, if each country produces to their absolute

advantage …below…

.

.

increase in World Output!!

exports them to India
India produces cloth and exports it to

the EU

TRADE BASED ON ABSOLUTE ADVANTAGE

India … for 12 yards of cloth?

both countries) is known as the gains from trade

Worked
What are the EU’s relative prices (opp. cost) … Bread?

Steel?
What are Canada’s relative prices (opp. cost) … Bread? Steel?

Who has absolute advantage in Bread?
Who has absolute advantage in Steel?

Given 2 working hours per country… what is the maximum world output?

wealth

If no nation imports, every company will be limited by

the size of its home country market

Imports enable a country to obtain goods that it cannot make itself or can make only at very high costs

Trade barriers decrease the size of the potential market, hampering the prospects of specialization, technological progress, mutually beneficial exchange, and, ultimately, wealth creation

barriers (Tariffs, Quotas, Subsidies…)

Trade barriers decrease
- Specialization
- Technological progress
-

Wealth creation

The modern view of trade shares Smith’s dislike for trade barriers

factor of production
This implies that the pre-trade price of a

good is determined by the amount of labor it took to produce it.

TRADE BASED ON ABSOLUTE ADVANTAGE

…
U.S. has an Absolute Advantage in both goods.

there is obviously no opportunity to trade… especially not for

U.S.
NO… No … No!!! This is not correct. We need to introduce the concept of:
Comparative Advantage Next lecture

production of one particular good – the more the better
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