Trade theories:

Concerned about a country

What products to import & export?
How much to trade?
With whom to trade?Which products companies might able to
sell from both domestic & foreign sources?
1. Mercantilism
Country should export more than they
import-to create gold reserve (power)
BOP -Favourable/unfavourable
2. Neo-mercantilism:
Attempts to run an export surplus to
achieve some social or political
objectives.

Export to get full employment

Export to maintain political influence
3. Absolute advantage-Adam Smith 1776
Why countries need to trade at all?
Real wealth of a country consists of
goods and services available.
A countrys wealth is based on its
available goods & services rather than
on gold
Specialization
-Labor could become more skilled by
doing the same tasks.
-Labor would not lose time in
switching from the production of one
kind of product to another.
-Long production runs would provide
incentives for the development of
more effective working methods.

Natural advantage: refers to climate

& Natural resources.
Acquired advantage: refers to
technology and skill development.
-Manufactured goods & services
Theory of country size:
Bigger countries differ in several
ways from smaller countries. They
-Tend to export a smaller portion of
output and import a smaller part of
consumption.
-Have higher transport costs for
foreign trade.
Can handle large-scale production.

2. Comparative advantage: David

Ricardo 1817

What happens when one country can

produce all products at an absolute
advantage?
Gains from trade will occur 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 of the theory of
specialization:
Full employment-not a valid
assumption-resources are fully
employed (both the theories)
countries have idle resources seek
to restrict imports in order to
employ idle resources.
Economic efficiency objective
Division of gains
Two countries, two commodities

 Transport costs
Mobility Resources are neither as
mobile nor as immobile as the
theories of absolute and
comparative advantage assume.
Services
4. Factor proportion theory:
Factors in relative abundance are
cheaper than factors in relative scarcity
-Earlier theories did not help to identify
the type of products that would most
likely give a country an advantage.