International Trade Theories Essay Example for Free

Intertheme Trade Theories Es govern1. Theory of Mer targettilism introMercantilism is a sight surmisal holing that a commonwealths wealth is measured by its holdings of treasure which usu altogethery essence its gold. The mercantilists proposed theory of mercantilism. They were a group of economists who preceded Adam Smith. The foundations of economic thought between 1500 and 1800 were found on mercantilism. Mercantilists believed that the b tot entirelyy had a finite store of wealth therefore, when wiz countrified got to a greater extent than, separate countries had slight. Mercantilists restricted importees and encouraged or subsidized tradeationations as a conscious form _or_ system of g everyplacenment to check their citizens meliorate off. Mercantilists judged the success of throw by the size of the softwood equalizer.Mercantilism was a sixteenth-century economic philosophy that well-kept that a kingdoms wealth was measured by its holdings of gold and si lver. This required that the countries to maximize trades and minimize imports. The logic was transpargonnt to sixteenth-century policy describers that if orthogonalers bought much goods from us than we bought from them, and so the foreigners had to pay us the difference in gold and silver, enabling us to amass more treasure. With that treasure we could expand the nations global influence.Mercantilists pressed for favorable balance of raft (BOT) or balance of payments (BOP) as against the unfavorable star. In a way it is good be reasonableness your currentness appreciates with mounting surfeit on the Fore front, and the country can attract more foreign crownwork infusion further strengthening the countrys economy, infrastructure, etc. Now chinaware and Japan with considerable favorable BOT and BOP get all the benefits envisaged by mercantilists.According To Adam Smith--Mercantilism is an economic theory usual in the 1500s and was the biggest reason for Europes desire to colonize new visits the theory states that there is a certain amount of wealth in the world and it is in a nations best interest to stack up it by wealth, a nation can achieve power a country achieves wealth through producing and exporting more good then they import this theory was invented to serve the interest of the empire, non the villageEvaluation of Mercantilism TheoryMercantilist writers have been lauded and criticized in the literature on foreign softwood at least since Humes Political Discourses in 1752. Mercantilists have been criticized for allthing from their views regarding the gains from trade to their self-promotion of the merchants economic consumption in society as being important. Mercantilist writers chance ond that the economy leave alone generally operate at a pace that leaves resources land and crunch idle, provided in reality the economy naturally tends to full employment. This is a flaw in the logical foundation of mercantilist thought. The reg ime of WTO has moved the world away from mercantilism by pressing for free trade with reduced protectionism.Theory of Neo-MercantilismMercantilism is subdued in vogue. Mercantilist policies be politi gro usey attractive to some firms and their workers, as mercantilism benefits certain members of society. Modern supporters of these policies are known as neo-mercantilists, or protectionists. The neo-mercantilists want higher payoff through full employment and that every industry affirms an exportable surplus leading to favorable BOT. Consciously or oppositewise, every country is concerned about increasing export earnings. The merits of surging Fore surplus built through exports speaks well of a countrys capableness to cater to worlds needs qualitatively, quantitatively and in varied product/ emolument ranges. all country does what is possible to meet this end. But the modern trade emphasis is Export more and mo more. ultimatelyThe main economic system used during the sixteenth to eighteenth centuries. The main goal was to increase a nations wealth by imposing government regulation concerning all of the nations commercial interests. It was believed that national strength could be maximized by limiting imports via tariffs and maximizing exports. This approach assumes the wealth of a nation depends mainly on the possession of precious metals such as gold and silver. This type of system can non be maintained forever, because the global economy would become stagnant if every country wanted to export and no one wanted to import. After a period of time, many people began to revolt against the idea of mercantilism and accent the need for free trade.Mercantilism is a theory developed by the merchants hence the name. It rests on the role of a strong state in supporting (state-granted) monopolies and protecting shipping and transaction lanes. Mercantilism encourages exports and discourages imports. currency and silver are used to keep score of the game played between nation-states, and represent the wealth of the nation._______________________________________________________________2. Absolute Advantage theoryIntroductionAdam Smith, in The Wealth of Nations, postulated that under free trade, each nation should specialize in producing those goods that it could upraise nearly efficiently. around of these would be exported to pay for the imports of goods that could be sustaind more efficiently elsewhere.Smith ridiculed the fear of trade comparing nations to households. Since every household finds it worthwhile to promote that some of its needs and to buy others with products it can seal, the same should apply to nationsIt is the maxim of every prudent acquire of a family, never to attempt to make at home what it give court him more to make than to buy. The Taylor does not attempt to make his own shoes, further buys them from shoemaker What is prudence in the conduct of every orphic family, can scarce be folly in that of a great k ingdom. If a foreign country can return us with some part of the product of our own industry, employed in a way in which we have some comfort.The theory of absolute payoff is based on the assumption that the nation is absolutely better (i.e., more efficient) at exertion of certain goods than are its trading partners. Smith showed by his mock up of absolute advantage that some(prenominal) nations would gain from trade.ADAM SMITHS TRADE guess OF ABSOLUTE ADVANTAGEThe first classical theory of international trade was propounded by Adam Smith, the bump of classical economics. His theory is known as the Theory of Absolute Advantage.It may be possible for all the countries to produce all the commodities they need, in spite of resource constraint. But, the cost of mathematical product of goods for which a country is lacking(predicate) in its resources would be exorbitantly high. It is better to import such goods rather than produce them. Most Countries therefore tend to special ize in producing commodities in which they have absolute advantage in cost of production. Therefore, most countries export goods which they can produce at a reduce cost and import what they can produce at a higher cost. This common intellect logic of international division of labor suggested by Adam Smith marks the beginning of modern theories of foreign trade.The theory of absolute advantage states that the butt of trade between the nations is the absolute advantage a country has in producing a commodity over the other countries. In simple members, devil countries are able to trade between them because each one of them is able to produce at least one commodity at a comparative degreely starter cost.AssumptionsThe theory of absolute advantage was advanced to buttress Smiths argument that if there was no government involution in trade, and if each individual was left to do what in his or her own best interest, then there would be more goods and ser ungodlinesss useable, pri ces would be reduced, and the wealth of each nation, measured as the offbeat of the citizens, would increase. Smiths theory was offered to replace mercantilism. The Theory of Absolute Advantage and the Theory of relative Advantage rest on very strong assumptions, as followsTwo countries, two commodities assumed in both theories. The theories are apparent for this case. The three-by-three case (and those beyond) cannot be established analytically, and it is not redden clear how the principle should be formalized. (See p. 3 of Ronald Jones, The despotic Theory of International Trade, Handbook of International Economics, R. Jones and P. Kenen (eds.), 1984.)Efficiency objective The Absolute and Comparative Advantage theories assume that total world production, and therefore efficiency, is the objective. Efficiency is not always a country goal.Zero raptus Costs both theories presume that bearation be between and within countries are zero.Factor Mobility/ unalterability both t heories presume that resources are absolutely mobile within a country and absolutely steadfast between countries.Full employment Both theories assume full employment in each country.Comparative Advantage versus Absolute AdvantageAs we can see from the example above, a country can have a comparative degree degree degree advantage in producing a good even if it is absolutely less efficient at producing that good. To understand this more clearly, think of an example of a rectify in private practiceA young doctor opens her own practice, working by herself, and within a some months has developed a substantial clientele. At first, she was performing all her clerical workfiling, typing and respondent the phoneby herself. With an ever-busier schedule, however, she realizes that she could spend more time seeing patients, and thus see a greater number of patients, if she hired an assistant.As it turns out, the young professional is not only a brilliant doctor, but is overly lightning-fa st at typing and filing. She is, in fact, better at doing both jobs than the clerical assistant she hires. In other words, she has an absolute advantage at both tasks medical diagnosis and clerical work.Does it make sense then for the doctor and her assistant to share both tasks, each spending part of the day examine patients and doing clerical work? The answer is no. By having the assistant perform all the clerical work, the doctor is able to maximize her specialty and see more patients. The patients are undoubtedly better off too.In other words, even though the assistant is worse at performing both tasks, an economist would say that he nonetheless has a comparative advantage at clerical work. As you can see, by working together trading their services the doctor and the assistant are able to maximize their skills, make both better off.As these examples show, trade allows countries to specialize in the production of what they do best and make the most efficient use of their res ources, thereby decreasing the price of both goods. No matter how inefficiently a country produces every kind of good, it can always be said to have a comparative advantage in at least one of those goods.That is the theory of comparative and absolute advantage. It helps develop what happens in the real world of international trade, and it offers broad guidance to countries as they decide which goods and services to produce and subsequently export, and which, in turn, to import.Trade in Theory and PracticeIn reality, of course, trade specialization does not work precisely the way the theory of comparative advantage might suggest, for a number of reasonsNo country specializes exclusively in the production and export of a single product or service. alone countries produce at least some goods and services that other countries can produce more efficiently.A lower income country might, in theory, be able to produce a particular product more efficiently than the United States can but stil l not be able to identify American buyers or transport the item cheaply to the United States. As a result, U.S. firms continue to manufacture the product.FinallyThe Scottish economist Adam Smith developed the trade theory of absolute advantage in 1776. A country that has an absolute advantage produces greater output of a good or service than other countries using the same amount of resources. Smith stated that tariffs and quotas should not restrict international trade it should be allowed to flow according to market forces. Contrary to mercantilism Smith argued that a country should press on production of goods in which it holds an absolute advantage. No country would then need to produce all the goods it consumed. The theory of absolute advantage destroys the mercantilist idea that international trade is a zero-sum game.3. Comparative Advantage theoryIntroductionDavid Ricardo, in 1817, enunciated his refinement of Smiths conceit by postulating the principle of comparative advanta ge (as opposed to Smiths concept of absolute advantage). The theory of comparative advantage states that even if a country is able to produce all its good at lower costs than some other country can, trade still benefits both countries, based on comparative costs. His writings demonstrated what has become known as the principle of comparative advantage a nation, like a person, gains from the trade by exporting the goods or services in which it has its superior comparative advantage in productivity and importing those in which it has the least comparative advantage.The key word is comparative, meaning relative and not necessarily absolute. There are gains from trade whenever the relative price ratios of two goods differ under international diversify for what would be under conditions of no trade. In addition, the theory of comparative advantage demonst order that countries jointly benefit from trade (under the assumption of both goods).With the theory of absolute advantage, Ricard os theory of comparative advantage does not answer why production cost differ within each country and also no consideration is flown to the possibility of producing the same goods with different combinations of meanss.AssumptionA government agency in which a country, individual, company or region can produce a good at a lower opportunity cost than a competitor. This theory that global efficiency gains may still result from trade if a country specializes in those products it can produce more efficiently than other products-regardless of whether other countries can produce those same products even more efficiently. It denotes gains from trade lead pass away even in a country that has absolute advantage in all products because the country must give up less efficient output to produce more efficient output.Assumptions underlying the concept of comparative advantage Perfect occupational mobility of meanss of production resources used in one industry can be switched into another without any loss of efficiency Constant returns to scale (i.e. doubling the inputs in each country leads to a doubling of total output) No externalities arising from production and/or consumption Transportation costs are ignored comparative advantage and international tradeComparative advantage exists when a country has a margin of superiority in the production of a good or service i.e. where the opportunity cost of production is lower. The basic theory of comparative advantage was developed by David Ricardo Ricardos theory of comparative advantage was further developed by Heckscher, Ohlin and Samuelson who argued that countries have different factor endowments of labor, land and large(p) inputs. Countries will specialize in and export those products which use intensifierly the factors of production which they are most endowed.If each country specializes in those goods and services where they have an advantage, then total output and economic welfare can be increased (under cert ain assumptions). This is true even if one nation has an absolute advantage over another country. Worked example of comparative advantage consider the data in the pastime table Pre-Specialization CD Players personalised Computers UK 2,000 500 Japan 4,000 2,000 Total Output 6,000 2,500 After trade has taken place, total output of goods available to consumers in both countries has grown. UKs consumption of CD players has increased by 200 and they have an extra deoxycytidine monophosphate PCs. For Japan, they have an extra 200 CD players and 200 PCs. If businesses exploit increasing returns to scale (i.e. economies of scale) when they specialize, the potential gains from trade are much greater. The idea that specialization should lead to increasing returns is associated with economists such as swell of the United States of Minnesota Romer and Paul Ormerod Determinants regarding comparative advantageComparative advantage is a dynamic concept. It can and does change o ver time. Some businesses find they have enjoyed a comparative advantage in one product for some(prenominal) age only to face increasing competition as rival producers from other countries enter their markets. For a country, the following factors are important 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 labor force and the productivity of the existing stock of capital inputs). If an economy can improve the quality of its labor 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 outgrowth (important in industries where patents give some firms significant market advantage) for more information on this have a look at this page Movements in the exchange rate. An appreciation of the exchange rate can cause exports from a country to increase in price. This makes them les s competitive in international markets. Long-term rates of inflation compared to other countries. For 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 countrys domestic producers- although most countries agree to a childs playe by international trade agreements. Non-price competitiveness of producers (e.g. product design, reliability, quality of after-sales support)CriticismsHowever, the principle of comparative advantage can be criticized in a several ways It may overstate the benefits of specialization by ignoring a number of costs. These costs include transport costs and any external costs associated with trade, such as air and sea pollution. The theory also assumes perfect mobility of factors without any diminishing returns. The reality may be very different. Output from factor inputs is in all probability to be subject to diminishing returns. This will make the PPF for each country non-linear and bowed outwards. Complete specialization might create structural unemployment as some workers cannot transfer from one sector to another. Relative prices and exchange rates are not taken into account in the simple theory of comparative advantage. For example if the price of X rises relative to Y, the benefit of increasing output of X increases. Comparative advantage is not a static concept it may change over time. For example, nonrenewable resources can slowly egest out, increasing the costs of production, and reducing the gains from trade. Many countries strive for food security, meaning that even if they should specialise in non-food products, they still prefer to keep a minimum level of food production. Finally, the princ iple of comparative advantage is derived from a simple two good/two country model. The real world is far more complex, with countries exporting and importing many different goods and services.FinallyIt seems obvious that if one country is better at producing one good and another country is better at producing a different good (assuming both countries demand both goods) that they should trade. What happens if one country is better at producing both goods? Should the two countries still trade? This question brings into play the theory of comparative advantage and opportunity costs. The everyday choices that we make are, without exception, made at the expense of pursuing one or several other choices. When you decide what to wear, what to eat for dinner, or what to do on Saturday night, you are making a choice that denies you the opportunity to explore other options.______________________________________________________________4. Heckscher-Ohlin theoryIntroductionthe HeckscherOhlin theo rem is one of the four critical theorems of the HeckscherOhlin model. It states that a country will export goods that use its plethoric factors intensively, and import goods that use its scarce factors intensively. In the two-factor case, it states A capital- copious country will export the capital-intensive good, while the labor-abundant country will export the labor-intensive good.DefinitionThis theory said that differences in countries endowment of labor compared to their endowment of land or capital explain differences in the cost of production factors.AssumptionThe critical assumption of the HeckscherOhlin model is that the two countries are identical, except for the difference in resource endowments. This also implies that the aggregate preferences are the same. The relative copiousness in capital will cause the capital-abundant country to produce the capital-intensive good cheaper than the labor-abundant country and vice versa.Initially, when the countries are not trading t he price of capital-intensive good in capital-abundant country will be bid down relative to the price of the good in the other country, the price of labor-intensive good in labor-abundant country will be bid down relative to the price of the good in the other country.Once trade is allowed, profit-seeking firms will move their products to the markets that have (temporary) higher price.As a result the capital-abundant country will export the capital-intensive good, the labor-abundant country will export the labor-intensive good.Features of the model Relative endowments of the factors of production (land, labor, and capital) determine a countrys comparative advantage. Countries have comparative advantages in those goods for which the required factors of production are relatively abundant locally. This is because the advantageousness of goods is determined by input costs. Goods that require inputs that are locally abundant will be cheaper to produce than those goods that require inputs that are locally scarce. For example, a country where capital and land are abundant but labor is scarce will have comparative advantage in goods that require lots of capital and land, but little labor grains. If capital and land are abundant, their prices will be low. As they are the main factors used in the production of grain, the price of grain will also be lowand thus attractive for both local consumption and export. Labor intensive goods on the other wad will be very expensive to produce since labor is scarce and its price is high. Therefore, the country is better off importing those goods.Factor Proportions TheoryTrade theory, like all of economic theory, changed drastically in the first half of the twentieth century. The factor proportions theory developed by the Swedish economist Eli Heckscher and after expanded by his former graduate student Bertil Ohlin formed the major theory of international trade that is widely is still widely accepted today. Whereas Smith and Ricard o emphasized a labor theory of value the factor proportions theory was based on a more modern concept of production that embossed capital to the same level of importance as labor.Factor Intensity in ProductionThe factor intensity in production theory considered two factor of production, labor and capital. Technology determines the way they link up to form a product. Different products required different proportions of the two factors of production.It is easy to see how the factor proportions of how a product is produced differs substantially among groups of products. For the manufacturing of leather footwear is still a relatively labor intensive treat even with the most sophisticated leather treatment and patterning machinery. Other products such as computer reposition chips, however although requiring some highly skilled labor require massive quantities of capital for production and nurture and the manufacturing facilities needed for clean production to ensure the extremely hi gh quality demanded in the industry. The concept of factor proportions is very useful in the comparison of the production processes of goods.According to factor proportions theory, factor intensities depend on the state of technology and the current method of manufacturing a product. The theory assumed that the same technology of production would be used for the same goods in all countries. It is not therefore differences in the efficiency of production that will determine trade between countries at it did in classical theory. Classical theory implicitly assumed that technology or the productivity of labor is different across countries. Otherwise there would be no logical explanation as to why one country requires more units of labor to produce a unit of output than another country. Factor proportions theory assumed no such productivity differences.Factor Endowments, Factor Prices, And Comparative AdvantageIf there is no difference in technology or productivity of factors across cou ntries, what then determines comparative advantage in production and export? The answer is that factor prices determine cost differences. And these prices are determined by the endowments of labor and capital the country possesses. The theory assumes that labor and capital are immobile, meaning they cannot move across country borders. Therefore the countrys endowment determines the relative costs of labor and capital as compared to other countries.Each country is defined or measured by the amount of labor and capital that it possesses. If a country has when compared with other countries more labor and less capital it would be characterized as relatively labor abundant. That which is more plentiful is cheaper so a labor abundant country would therefore have relatively cheap labor.For a country such as China possesses a relatively large endowment of labor and a relatively smaller endowment of capital. At the same time Japan is a relatively capital abundant country with a relatively sm aller endowment of labor. China possesses relatively cheaper labor and should therefore specialize in the production and export of labor intensive products. Japan possesses relatively cheap capital and should specialize in the production and export of capital intensive products. Comparative advantage is derived not from the productivity of a country, but from the relative abundance of its factors of production.Using these assumptions, factor proportions theory stated that a country should specialize in the production and export of those product that use intensively its relatively abundant factor.(i) A country that is relatively labor abundant should specialize in the production of relatively labor intensive goods. It should then export these labor intensive goods in exchange for capital intensive goods.(ii) A country that is relatively capital abundant should change in the production of relatively capital intensive goods. It should then export these capital intensive goods in excha nge for labor intensive goods.FinallyThe Heckscher-Ohlin theory states that international and interregional differences in production costs occur because of differences in the supply of production factorsCommodities requiring for their production much of abundant factors of production and little of scarce factors are exported in exchange for goods that call for factors in the opposite proportions. Thus indirectly, factors in abundant supply are exported and factors in scanty supply are imported (Ohlin, 1933).These simple statements lead to an important conclusion under free trade, countries export the products that use their scarce factors intensively and imports the products using their scarce factors intensively.