2. International Trade
Theories
INTERNATIONAL
TRADE THEORIES
MERCANTILISM
THEORY OF
ABSOLUTE
ADVANTAGE
THEORY OF
COMPARATIVE
ADVANTAGE

3. Mercantilism
Thomas mun and others propagated this theory in
U.K. between 16th &17th century.
Gold and silver were used as medium of exchange
between countries.
Gold and silver were the mainstays of national
wealth.
Country should always maintain trade surplus by
exporting more than imported.
Government should intervene to achieve trade surplus
by imposing tariffs and quotas on imports and
subsidizing the exports.

4.  Mercantilism
 This
is viewed as Zero Sum Game.
theory is not suitable in the long run.
 Decay
of gold standard reduced the validity of
this theory.

5.  Adam
smith propounded this theory in 1776.
 He believed that trade is a positive sum game.
 Free trade enables a country to produce a
variety of goods and services.
 This theory is based on the principle of
division of labour.
 The countries which produce goods more
efficiently than the other countries has an
absolute advantage.
 Country should never produce goods that it
can buy at a lower rate from other countries.

6. Assumptions
 Trade
is between two countries
 Only
two commodities are traded
 Free
trade exists between the countries
 The
only element of cost of production is
labor.

7. Country
Sugar
Jute
India
10
20
Bangladesh
40
10
Production and consumption without trade.
Country
Sugar
Jute
India
10
5
Bangladesh
2.5
10
Note: The resources are divided equally i.e.,100 resources
for each.

8. Production with specialization
Country
Sugar
Jute
India
20
0
Bangladesh
0
20
Consumption after 6 tons of both are traded
between them.
Country
Sugar
Jute
India
14
6
Bangladesh
6
14
Increase in consumption due to trade
Country
Sugar
Jute
India
4
1
Bangladesh
3.5
4

9. Output per one day of labour
country
Pens
Tape recorders
Japan
20
6
India
60
2
Production and consumption without trade.
Output per one day of labour
country
Pens
Tape recorders
Japan
10
3
India
30
1
Note: The time is divided equally for manufacturing i.e.,
50%

10. Production with specialization
Output per one day of labor
Japan
India
Pens
0
60
Tape recorders
6
0
Production and consumption with trade.
Output per one day of labor
Japan
India
Pens
30
30
Tape recorders
3
3
Note: terms of trade 10 pens = 1 tape recorder.
Increase in consumption due to trade
Output per one day of labor
Japan
India
Pens
20
30
Tape recorders
3
2

11. Y
------- Japan PP(CD)
…….. Indian PP(EF)
Without trade:
Japan-A
India-B
With specialization:
Japan-C
India- F
60 F
P
e
n
s
50
40
india
B
30
20
10
0
D
japan
1
A
2
E
C
3
4
5
Tape recorders
6
X

12. 




Both the countries can have more quantities of
both the products.
Increases the standard of living due to increased
trade.
Inefficiency in producing certain products in some
countries can be avoided.
Global efficiency and effectiveness can be
increased by trading.
Global labour productivity and other resources
productivity can be maximised.

13.  No
absolute cost advantage.
 Country size.
 Fixed cost of resources.
 Transport cost.
 Assumed away the effects of trade on income
distribution within the country.
 Absolute advantage for many products.

14. 
This theory is propounded by David Ricardo in
1817.
 This
theory stress that comparative advantage
arises from differences in productivity.

15. 







Each country has a fixed stock of resources.
The only element of cost of production is
labour.
Production is the subject to the law of
constant returns.
All the units of labor homogeneous
There are no trade barriers.
Trade takes place only between two products
and two countries.
There is no cost of transportation.
There is a perfect competition

16. Country
Sugar
Jute
India
10
13.33
Bangladesh
40
20
Production and consumption without trade.
Country
Sugar
Jute
India
10
7.5
Bangladesh
2.5
5
Note: India allots 100 resources for sugar and 100resources
for jute.

17. Production with specialization
Country
Sugar
Jute
India
15
3.75
Bangladesh
0
10
NOTE: India allots 150 resources for sugar & 50 resources for jute
Consumption after trading 4 tons
Country
Sugar
Jute
India
11
7.75
Bangladesh
4
6
Increase in consumption due to trade
Country
Sugar
Jute
India
1
0.25
Bangladesh
1.5
1

18. y
20
S
A
E
15
U
G
A
R
------- PP of B’desh(5/10)
-------PP of India (15/20)
Without trade:
Bangladesh: F(2.5-5)
India-G(10-7.5)
With specialization
Bangladesh: D(0-10)
India: E(15-3.75)
G
10
C
5
2.5
F
D
0 3.75 5 7.5 10
JUTE
B
15
X
20

19.  Efficient
allocation of global resources.
 Maximization
of global production at the
least possible cost.
 Parity
among world markets.
 Demand
for resources and products will be
optimized.

20.  Only
two countries
 Transportation costs
 Only two products
 Nothing about exchange rates
 Assumed away differences in prices of resources
 Mobility
 Services