INTERNATIONAL ECONOMY

Theories of International Trade

Lecturer : Mr. Febri Dirgantara Hasibuan

Arranged by :

Dita Rekhana Aulia (11181130000112)

Nurly Erfina (11181130000128)

Geofanny Adityo (11181130000109)

Rizka Bunga Shafira (11181130000094)

INTERNATIONAL RELATIONS
FACULTY OF SOCIAL AND POLITICAL SCIENCE
STATE ISLAMIC UNIVERSITY
SYARIF HIDAYATULLAH
JAKARTA
2019
 CHAPTER II

I. The Concept of International Trade Theory

International economics deals with the economic and financial interdependence

among nations. It analyze the flow of goods, services, payments, and monies between
a nation and the rest of the world, the policies directed at regulating these flows, and
their affected by, and in turn influences, the political, social, cultural, and military
relations among nations.

Specifically, international economics deals with international trade theory,

international trade policy, the balance of payments and foreign exchange markets, and
open-economy macroeconomics. International trade theory analyzes the basic and the
gains from trade. International trade theory are the microeconomic aspects of
international economy because they deal with individual nations treated as single
units and with the (relative) price of individual commodities. On the other hand, since
the balance of payments deals with total receipts and payments, as well as with
adjustment and other economic policies that affect the level of national income and
the general price level of the nation as a whole, they represent the macroeconomic
aspects of international economics. These are often referred to as open-economy
macroeconomics or international finance.1

International trade is the exchange of good and services between countries. Trading
globally gives consumers and countries the opportunity to be exposed to goods and
services not available in their own countries, or which would be more expensive
domestically. The importance of international trade was recognized like Adam Smith
and David Ricardo. Still, some argue that international trade actually can be bad for
smaller nations, putting them at a greater disadvantage on the world stage.

International trade allows countries to expand their markets for both goods and
services that otherwise may not have been available domestically. As a result of
international trade, the market contains greater competition, and therefore more
competitive prices, which brings a cheaper product home to the consumer.
International trade gives rise to a world economy, in which supply and demand, and
therefore prices, both affect and are affected by global events.2

In ordinary language, trade refers to the sale purchase of goods. The broader meaning
of trade however it meant to include all those activities as a result of which goods
produced in a society are distributed for the purpose of consumption. In other words,
trade comprises all human activities which regulate goods from their production to
distribution. Trade is normally discussed as inter-regional trade and international
trade.

1
Dominick Salvatore, International Economics 11th edition, Fordham University,
USA, 2013, p. 12-13.
2

Access from https://www.investopedia.com/insights/what-is-international-

trade/ at Thursday, 12-09-2019, 21.31 pm.
I.1. Meaning of Inter-regional and International Trade

The trade of a company can be divided in two parts:

a. Inter-regional Trade:
It refers to the trade which is carried out in different places and regions of the same
country. It is also called inter-regional trade.

b. International Trade:
it is a trade between two or more than two countries. Trade between India and U.K is
called international or foreign trade. The goods consigned from India to U.K will be
known as India’s exports. On the other hand, goods coming from U.K to India will be
called India’s imports.

I.2. Definition of International Trade

A few definitions are as under:

a. “International Trade is a trade between nations”- Anatol Murad

b. “International Trade consist of transaction between residents of different

countries”- Wasserman and Haltman

c. “International Trade means in plain English trade between nations” - Edgeworth3

I.3. An Overview The Theory of International Trade

The foundations of international trade theory are contained in three main models
aimed at explaining the determinants of international trade and specialization:

a. The classical (Torrens-Ricardo) theory, according to which these determinants are

to be found in technological differences between countries

b. The Hecksher-Ohlin theory, which stresses the differences in factor endowments

between different countries.

c. The neoclassical theory (which has bad a longer gestation: traces can be found in
J.S Mill; A. Marshall takes it up again in depth, and numerous modern writers bring it
to a high level of formal sophistication), according to which these determinants are to
be found simultameously in the differences between technologies, factor endowments,
and tastes of different countries.4

II. The Basis of Trade Theory

3
Raj Kumar, International Economics 1st edition, New Delhi, 2008, p. 12-13.
4
Giancarlo Gandolfo, International Trade and Theory 2ndedition, Accademia
Nazionale dei Lincei, Italy, 2014, p.5.
II.1. Mercantilism

Mercantilism was an economic philosophy that happen during the seventeenth and
eighteenth centuries. Briefly, mercantilism means, if a countries want to be rich and
powerful they must export goods more than the imported. The resulting export surplus
would then be settled by an inflow of bullion, or precious metals, primarily gold and
silver. The more gold and silver a nation had, the richer and more powerful it was.
The government with all its power must stimulate the amount of export and restrict
the imports, specially the luxury consumption goods. However it was impossible if
every nation had a export surplus simultaneously, so its means one nation could gain
only at the expense of other nation.

The reasons why mercantilist’s desire for accumulation of precious metal is, with the
more gold, nation could build bigger and better military power, improved armies and
navies and made its possible to them to acquire more colonies, In addition, more gold
meant more money (gold coins) in circulation and greater business activity.
Furthermore, by encouraging exports and restricting imports, the government would
stimulate national output and employment.5

II.2. Absolute Advantage

According to Adam Smith when one nation is more efficient than another in produce
one commodity, but is less efficient than the onther nation to produce other
commodity, then both nation can gain more by each specializing in the producing the
commodity of its absolute advantage and exchanging part of its output with the other
nation for the commodity of its absolute disadvantage.

So if merkantilist’s believed that one nation could gain only at the expense of another
nation and advocated strict government control of all economic activity and trade.
Adam Smith believed otherwise, he believed that all nation would gain from free
trade. Free trade would cause world resource to be utilized most efficiently and would
maximize world welfare.6

II.3. Comparative Advantage

According to David Ricardo with the law of comparative advantage explain even if
one nation has an absolute disadvantage in the production of two commodities, there
is still a basis for mutually beneficial trade. The first nation should specialize in the
production and export the commodity with smaller absolute disadvantage and import
the commodity with greater absolute disadvantage.7

This theory was based on these assumptions :

5
Salvatore, Op.Cit.,p.30-31.
6
Ibid.,p.32-33.
7
Ibid.,p.34.
1. Only two nations and two commodities
2. Free trade
3. Perfect mobility of labor within each nation but immobility between the two
nations
4. Constant cost of productions
5. No transportation costs
6. No technical change
7. The labor theory of value

But the assumption about the labor theory of value was not valid and unacceptable to
explain comparative advantage.8

II.4. Heckscher-Ohlin Theory

The theory by Eli Hecksher And Bertil Ohlin was explain that a nation will export the
commodity whose production requires the intensive use of nation’s relatifly abundand
and cheap factor and import the commodity whose production requires the intensive
use of the nation’s relatively scarce and expensive factor.9

This theory is based on these assumptions:

1. There are two nation,commodities and factors of production
2. Both nation use the same technology in production.
3. The first commodity is labor intensive, and the second commodity is capital
intensive
4. Both commodity are produced under constant return scale in both nations
5. There is incomplete specialization in production in both nations
6. Tates are equal in both nations
7. There is perfect competition in both commodities and factor markets in both
nations.
8. There is perfect factor mobility within each nation but no international factor
mobility.
9. There are no transportation cost, tariffs, or other obstructions to the free flow of
international trade.
10. All resources are fully employed in both nations
11. International trade between the two nation is balanced10

III. The Benefit of Interational Trade

8
Ibid.,p.39.
9
Ibid.,p.120.
10
Ibid.,p.112.
III.1. The Benefit of International Trade:11

1. Obtain goods that cannot be produced in their own country

The condition of different natural resources and human resources in each country will
certainly greatly affect a production for each country. Therefore, with the existence of
international trade, there is an import activity where this activity can facilitate getting
goods and services that are not owned / produced by their own country. In addition,
with international trade we can get various goods and services with very cheap but
good quality.

So that in this case, if a country has goods that cannot be produced in that country,
with international trade, it can avoid a country from the economic crisis and create a
stable price by carrying out import activities. In addition, the benefits of imports can
also meet the needs of the country’s people from the scarcity of goods and services
needed. And others.

2. Establish relations between countries

International trade can establish and strengthen relations between nations, with trade
between countries, each country that works together will have a sense of need for
each other so that a sense of friendship grows. By being friendly among the nations,
the relations between countries will become more harmonious, because between
countries give mutual benefits to the countries that cooperate with the country.

Through a cooperation in the field of economics and trade between countries can
provide positive impacts such as expanding employment availability, accelerating
national development, reducing unemployment, increasing the prosperity of the
country.

3. Obtain profit from specialization

The main reason for International trade activities is to obtain the profit that realized by
specialization. Although a country can produce an item of the same type as that
produced by another country, but sometimes it is better if the country imports these
goods from abroad.

4. Expand the market

With the existence of international trade, encouraging producers to make as much as

possible the goods and services to be marketed abroad, so that producers can generate
11
Sadono Sukirno, Makroekonomi: Teori Pengantar Edisi 3 (Jakarta: Raja
Grafindo Utama, 2006) P.360-362
a lot of profits from the export proceeds abroad in fulfilling goods and services. With
the expansion into the market in free trade, local products can be competitive in
foreign markets so as to generate profits for the country in the form of foreign
exchange.

In addition, with market expansion, it has encouraged domestic economic activities to

compete in producing goods and services. And directly impact the need for as much
work as possible. This can reduce the unemployment rate of a country.

5. Modern Technology Transfer

Economic activities or international trade can be improved by increasing

technological means. To improve this technology, a country needs to innovate or
transfer modern technology from other countries so that it is expected that there will
be an increase in knowledge and influence on the welfare of society. In addition,
foreign trade allows a country to learn more efficient production techniques and more
modern management methods.12

CHAPTER III

CONCLUSION

12
Jimmy Hasoloan, “Edunomic: Peranan Perdagangan International dalam
Produktifitas dan Perekonomian”, Jurnal Ilmiah Pendidikan Ekonomi Vol.1 No.2
p.109-110
International trade is the exchange of good and services between countries. Trading
globally gives consumers and countries the opportunity to be exposed to goods and
services not available in their own countries, or which would be more expensive
domestically. The importance of international trade was recognized like Adam Smith
and David Ricardo.

The mercantilist believed that a nation could gain in international trade only at the
expense of other nations. As a result, they advocated restrictions on imports,
incentives for exports, and strict government regulation of all economic activities.

According to Adam Smith, trade is based on absolute advantage and benefits both
nations. (The discussion assumes a two-nation, two commodity world). That is, when
each nation specializes in the production of the commodity of its absolute
disadvantage, both nations end up consuming more of both commodities. Absolute
advantage, however, explains only a small portion of international trade today.

International trade can establish and strengthen relations between nations, with trade
between countries, each country that works together will have a sense of need for
each other so that a sense of friendship grows. By being friendly among the nations,
the relations between countries will become more harmonious, because between
countries give mutual benefits to the countries that cooperate with the country