1. The Theories of Trade

2. Learning Objectives
To understand the traditional
arguments of how and why
international trade improves the
welfare of all countries
To explore the similarities and
distinctions between international
trade and international investment

3. Evolution of Trade Theory
The Age of Mercantilism
Classical Trade Theory
Factor Proportions Trade Theory
International Investment and
Product Cycle Theory
The New Trade Theory: Strategic
Trade

4. Mercantilism
Mixed exchange through trade
with accumulation of wealth
Conducted under authority of
government
Demise of mercantilism
inevitable

5. Classical Trade Theory
The Theory of Absolute Advantage
– The ability of a country to produce a product
with fewer inputs than another country
The Theory of Comparative Advantage
– The notion that although a country may
produce both products more cheaply than
another country, it is relatively better at
producing one product than the other

6. Classical Trade Theory
Contributions
Adam Smith—Division of Labor
– Industrial societies increase output using
same labor-hours as pre-industrial society
David Ricardo—Comparative
Advantage
– Countries with no obvious reason for
trade can specialize in production, and
trade for products they do not produce
Gains From Trade
– A nation can achieve consumption levels
beyond what it could produce by itself

7. Factor Proportions Trade Theory
Developed by Eli Heckscher
Expanded by Bertil Ohlin

8. Factor Proportions Trade Theory
Considers Two Factors of Production
Labor
Capital

9. Factor Proportions Trade Theory
A country that is relatively labor
abundant (capital abundant)
should specialize in the
production and export of that
product which is relatively labor
intensive (capital intensive).

10. Product Cycle Theory
Raymond Vernon
Focus on the product, not its
factor proportions
Two technology-based
premises

11. Product Cycle Theory:
Vernon’s Premises
Technical innovations leading to
new and profitable products
require large quantities of capital
and skilled labor
The product and the methods for
manufacture go through three
stages of maturation

12. Stages of the Product Cycle
The New Product
The Maturing Product
The Standardized Product

13. The Product Cycle and Trade
Implications
Increased emphasis on technology’s
impact on product cost
Explained international investment
Limitations
– Most appropriate for technology-based
products
– Some products not easily characterized by
stages of maturity
– Most relevant to products produced through
mass production

14. The New Trade Theory:
Strategic Trade
Two New Contributions
Paul Krugman-How trade is
altered when markets are not
perfectly competitive
Michael Porter-Examined
competitiveness of industries on
a global basis

15. Strategic Trade
Krugman’s Economics of Scale:
Internal Economies of Scale
External Economies of Scale

16. Strategic Trade
Government can play a beneficial
role when markets are not purely
competitive
Theory expands to government’s
role in international trade
Four circumstances exist that
involve imperfect competition in
which strategic trade may apply

17. Strategic Trade
The Four Circumstances Involving
Imperfect Competition:
1.Price
2.Cost
3. Repetition
4.Externalities