Classical Theories of International Trade

proportion Trade
International Product Cycle
New Trade Theory
National Competitive Advantage

a person or a country to produce a particular good

or service at a lower marginal and opportunity cost over another. Even if one country is more efficient in the production of all goods (absolute advantage in all goods) than the other, both countries will still gain by trading with each other, as long as they have different relative efficiencies.

Opportunity cost is the cost of any activity measured in terms of the value of the next best alternative forgone (that is not chosen). It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices

another country in the production of a product when it

uses fewer resources to produce that product than the other country does.

the production of a good when that good can be

produced at a lower cost in terms of other goods.

argument

Should import even if the country is more efficient in

the product’s production than country from which it is buying.

Look to see how much more efficient. If only comparatively efficient, then import.

assumptions :
There are two countries and two commodities.
There is a perfect

competition both in commodity and factor market.
Cost of production is expressed in terms of labour i.e. value of a commodity is measured in terms of labour hours/days required to produce it. Commodities are also exchanged on the basis of labour content of each good.
Labour is the only factor of production other than natural resources.

particular country.
Labour is perfectly mobile within a country but perfectly

immobile between countries.
There is free trade i.e. the movement of goods between countries is not hindered by any restrictions.
Production is subject to constant returns to scale.
There is no technological change.
Trade between two countries takes place on barter system.
Full employment exists in both countries.
There is no transport cost.

absolute advantage in the production of both goods, Ricardo would

argue that specialization and trade are still mutually beneficial.

in which they have a comparative advantage, they maximize their

combined output and allocate their resources more efficiently.

advantage in both goods?

Comparative Advantage is the ability of a

country to produce a good at a lower opportunity cost than another country

We compare the degree of absolute advantage or disadvantage in the production of goods

TRADE BASED ON COMPARATIVE ADVANTAGE

cloth
1 Cloth = 0.2 machine
US -

Opportunity Costs

1 Machine = 3 cloth
1 Cloth = 0.33 machine

Comparative Advantage: U.S. More Efficient in the Production of Both Commodities

U.S. has bigger Absolute Advantage in production of Machines

than is does in producing cloth (5x more efficient in

machines … only 3x more efficient in cloth)

India’s absolute disadvantage is smaller in producing cloth than in producing machines

Thus the U.S. has a comparative advantage in machines and India has a comparative advantage in cloth

TRADE BASED ON COMPARATIVE ADVANTAGE

India has a comparative advantage in cloth production

Even if U.S.

has an absolute advantage in both goods, beneficial trade is possible

If both countries specialize according to their comparative advantage, they both can gain from this specialization and trade

TRADE BASED ON OPPORTUNITY COSTS

across 15 yards of cloth
.
(per)
Let us allow India to produce

cloth up to the level that the U.S. can…

Advantage
TRADE BASED ON COMPARATIVE ADVANTAGE

efficient in producing both goods, but it will have a

comparative advantage in only one good.

Even if a country is the most (or least) efficient producer of all goods, it still can benefit from trade.

result from specialization and trade

Dynamic gains from trade are gains

from trade over time that occur because trade induces greater efficiency in the use of existing resources

DYNAMIC GAINS FROM TRADE

and consumption
Only 2 countries engaged in production and consumption of

just 2 goods?
What about the transportation costs?
Only resource – labor (that too, non-transferable)
No consideration for ‘learning theory’

quality of labor, land, and natural resources of a country.
Factor

endowments seem to explain a significant portion of actual world trade patterns.

the existence of a country’s comparative advantage by its factor

endowments.
According to the theorem, a country has a comparative advantage in the production of a product if that country is relatively well endowed with inputs used intensively in the production of that product.

It can and does change over time. Some businesses find

they have enjoyed a comparative advantage in one product for several years only to face increasing competition as rival producers from other countries enter their markets. 

in determining the relative costs of production:

The quantity and quality of

factors of production available (e.g. the size and efficiency of the available labour force and the productivity of the existing stock of capital inputs). If an economy can improve the quality of its labour force and increase the stock of capital available it can expand the productive potential in industries in which it has an advantage.

Investment in research & development (important in industries where patents give some firms significant market advantage)

Movements in the exchange rate. An appreciation of the exchange rate can cause exports from a country to increase in price. This makes them less competitive in international markets.

example if average inflation in Country X is 4% whilst

in Country B it is 8% over a number of years, the goods and services produced by Country X will become relatively more expensive over time. This worsens their competitiveness and causes a switch in comparative advantage.

Import controls such as tariffs and quotas that can be used to create an artificial comparative advantage for a country's domestic producers- although most countries agree to abide by international trade agreements. 

Non-price competitiveness of producers (e.g. product design, reliability, quality of after-sales support)

differences in productivity levels between countries exist.
It makes extreme and

unrealistic predictions such as countries will completely specialize in the production of exportables only.
It maintains that the gains from trade are greater between countries of dissimilar production technologies (despite the fact that most trade occurs between DCs with similar technology and income levels).

a motive for trade between developed and developing countries
It explains

why high-wage countries may still benefit from trade even when faced with low-wage competing countries

a country to possess absolute advantage in order to participate

in trade. What is required is comparative advantage in production.

A country will specialize in and export that good in which its has comparative advantage, i.e., has a lower pre-trade relative price than in the other country.

The terms of trade or world price will settle between the autarky prices of the two countries and is determined by reciprocal demand.