Presented By Dr. S P Das PhD (Economics), M. Phil (Economics), M.B.A. (Finance), M.A.

(Economics), UGC- NET (Management), UGC-SET (Economics), MCCP, PGDM, PGDFM, B.Com.

International Trade Theories

International Trade Theories .Theory of Mercantilism .Theory of Absolute Cost Advantage .Theory of Comparative Cost Advantage .Theory of Purchasing Power Points .Product Life Cycle Theory (PLC) .Theory of Competitive Advantage .Others* .Heckscher-Ohlin Model Leonief Paradox .Market Imperfections Approach .Transaction Cost Approach .The Eclectic Paradigm

Theory of Mercantilism .Practiced throughout Europe during16th to 18th Century .The mercantilists believed that the power of a nation lied in its wealth, which grew by acquiring gold from abroad. .Believed that the possession of wealth, gold and silver, was the sign of a strong nation which could finance military expeditions and wars. .Nationalism and the welfare of the nation alone was the only goal of the government .Thus, planning and regulating of economic activities by encouraging exports and restricting or even prohibiting imports was the feature of mercantilism. . Mercantilist believed that exports would create employment

A. Smith & Ricardo on Mercantilism .Smith & Ricardo by stressing the importance of individuals, and pointing out that their welfare was the welfare of the nation, rejected theory of mercantilism. .They believed in liberalism and enlightenment, and treated the wealth of the nation in terms of the "the sum of enjoyments" of the individuals in society. .Any activity, which would increase the consumption of the people, was to be considered with favour. .Smith & Ricardo advocated doctrine of free trade and the specialisation in the production of those goods where resources were most suitable.

Theory of Absolute Cost Advantage (ACA) .Propounded by Adam Smith (1776) .The countries gain from trading, if they specialise according to their production advantages. .Assumptions: .Trade is between two countries .Only two commodities are traded .Free trade between trading nations .Only cost element is Labour Cost. .A country is said to have ACA over its trading partner when it can produce more of an output with a given amount of inputs.

Example 1: PensTapesJapan206India602Output / one day of labourCountry

Criticism of ACA .No Absolute Advantage .Country Size ignored .Variety of resources .Transport Cost ignored .Scale Economies

Comparative Cost Advantage Theory & Opportunity Cost .David Ricardo (1817) pointed out that cost advantage to both the trade partners was not a necessary condition for trade to occur. .It would still be beneficial to both the trading countries even if one country can produce all the goods with less labour cost than the other country. .So long as the other country is not equally less productive in all lines of production, measurable in terms of opportunity cost of each commodity in the two countries.

Assumptions of CCA .Existence of full employment .Production only element of cost .Production Law of Constant Returns .No Trade barriers .Trade only between two countries .Only two products traded .No Transportation Cost

Example 2: PensTapesJapan606India502CountryOutput / one day of labourPensTapesJapan1.203.00India0.830.33Opportunity Cost CountryCost Without TradeWith TradeJapan1 Tape = 10 Pens1 Tape = 17.5 PensIndia1 Tape = 25 Pens1 Tape = 17.5 Pens

Comparative Advantage with Money (PPP) .The international trade is settled for money. .The quantity of inputs (labor) cost is measured in terms of money. .The foreign exchange rate affects the comparative cost advantage and accordingly the international trade. .Suppose; .Daily wage rate in Japan is Yen 360 .Daily wage rate in India is Rs. 100 .The exchange rate is INR 1 = 2 Yen .Then, the cost structure would be as follows:

PensTapesJapan (Yen)660India (Rs.)250CountryLabor Cost MakePensTapesJapanese (D)660Indian4100Cost of Goods in Japan MakePensTapesJapanese330Indian (D)250Cost of Goods in India

Criticism of CCA .Two countries .Two Products .No Transportation Cost .Full Employment .Economic Efficiency .Mobility of Factors .Ignores services

Product Life Cycle (PLC) Theory .Propounded by Posner (1961) and Vernon (1966) .In Posner's words, "Long-term patterns of international trade are influenced by product innovation and subsequent diffusion. A country that produces technically superior goods will sell these first to its domestic market, then to other technically advanced countries. In time, developing countries will import and later manufacture these goods, by which stage the original innovator will have produced new products. .International PLC consists of four stages .New Product Introduction .Growth .Maturity .Decline

International Changes during a PLC Introduction Growth Maturity Decline Production Innovative Industrialized Country Innovative & Other industrial countries Multiple Countries Mainly in LDCs Market Location Home with little exports Mainly Industrial Countries More in LDCs than industrialized countries Mainly in LDCs. Competitive Factors Near Monopoly; Sales based on uniqueness rather than price; evolving product features Fast Growing Demand; Increase in competitors; some competitors begin price cutting; standardized products Overall Stabilized demand; decrease in competitors; Price sensitivity especially in LDCs

Overall declining demand; Price is key; Decrease in producers Production Technology Short Production runs; High labour skills required. Capital input increase; production standardized Long Prod Runs; High standardization; Less labor skills Unskilled labor on mechanized long prod runs

Limitations of PLC .Short PLC restricts movement of production from one country to another and also further innovations .In case of luxury products cost reduction is of little concern .No significant exports due to high transportation cost .Requirement of specialist and experts may restrict movement of production from one country to another .Rapid technological development may not shift the production to various countries .MNCs follows geocentric approach

Competitive Advantage Theory Firm Strategy, Structure & Rivalry Related & Supported Industries Factor Conditions Demand Conditions

Porter s Model

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