Notes on Introduction to International Trade
1 Introduction to International Trade
1.1 Meaning
International trade refers to the exchange of goods, services, and capital across na-
tional borders. It involves transactions between residents of different countries, includ-
ing exports (selling goods/services abroad) and imports (purchasing goods/services from
abroad). International trade is a key component of global economics, facilitated by agree-
ments, policies, and institutions like the World Trade Organization (WTO).
1.2 Need for International Trade
• Resource Allocation: Countries access resources (raw materials, technology, la-
bor) unavailable or scarce domestically.
• Economic Growth: Expands markets, increases production, and boosts GDP
through exports.
• Consumer Benefits: Provides access to a wider variety of goods and services at
competitive prices.
• Specialization: Enables countries to focus on producing goods where they have
an advantage, improving efficiency.
• Foreign Exchange: Generates foreign currency through exports, stabilizing economies.
• Global Integration: Promotes economic and cultural interdependence, fostering
peace and cooperation.
• Innovation and Technology Transfer: Encourages the spread of advanced tech-
nologies and practices.
2 Theories of International Trade
2.1 Classical Theories
2.1.1 Mercantilism
• Overview: Dominant in the 16th18th centuries, mercantilism viewed trade as a
zero-sum game, emphasizing wealth accumulation through a favorable balance of
trade (more exports than imports).
• Key Points:
– Countries should maximize exports and minimize imports to accumulate gold
and silver.
– Heavy government intervention through tariffs, subsidies, and colonial policies.
– Focus on national power and wealth, often at the expense of other nations.
• Criticism: Ignores mutual benefits of trade and overemphasizes precious metals
as wealth.
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2.1.2 Absolute Advantage (Adam Smith, 1776)
• Overview: A country should specialize in producing and exporting goods it can
produce more efficiently (with fewer resources) than other countries.
• Key Points:
– Trade benefits countries with absolute advantages in specific goods.
– Example: If Country A produces wine cheaper than Country B, and Country
B produces cloth cheaper, both benefit by specializing and trading.
– Promotes efficiency and mutual gains from trade.
• Limitation: Fails to explain trade when one country has an absolute advantage in
all goods.
2.1.3 Comparative Advantage (David Ricardo, 1817)
• Overview: A country should specialize in goods it produces relatively more effi-
ciently (with lower opportunity cost) compared to other goods, even if it lacks an
absolute advantage.
• Key Points:
– Trade is beneficial as long as opportunity costs differ between countries.
– Example: If Country A is less inefficient in producing wine than cloth com-
pared to Country B, it should specialize in wine and trade for cloth.
– Explains why all countries, regardless of productivity, can benefit from trade.
• Limitation: Assumes constant costs, no trade barriers, and static resource endow-
ments.
2.2 Modern Theories
2.2.1 Resource and Trade Theory (Heckscher-Ohlin Theory)
• Overview: Developed by Eli Heckscher and Bertil Ohlin, this theory states that
countries export goods that use their abundant resources intensively and import
goods that use their scarce resources.
• Key Points:
– Based on factor endowments (land, labor, capital).
– Example: A labor-abundant country exports labor-intensive goods (e.g., tex-
tiles) and imports capital-intensive goods (e.g., machinery).
– Explains trade patterns based on resource availability.
• Limitation: Assumes identical technology across countries and oversimplifies trade
patterns (Leontief Paradox).
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2.2.2 Specific Factor and Income Distribution
• Overview: An extension of the Heckscher-Ohlin model, focusing on how trade
affects income distribution when some factors of production (e.g., capital, labor)
are specific to certain industries.
• Key Points:
– Specific factors (e.g., machinery in manufacturing) cannot easily move between
industries.
– Trade benefits owners of factors used in export industries but may harm those
in import-competing industries.
– Example: In a labor-abundant country, trade increases wages for workers in
export sectors but may reduce income for capital owners in import-competing
sectors.
• Limitation: Complex to predict income effects due to varying factor mobility and
market dynamics.
2.2.3 Standard Model of Trade
• Overview: A general equilibrium model combining elements of classical and mod-
ern theories to explain trade patterns based on supply, demand, and relative prices.
• Key Points:
– Uses production possibility frontiers (PPF) and indifference curves to analyze
trade.
– Trade allows countries to consume beyond their PPF by specializing in goods
with comparative advantage.
– Incorporates terms of trade (relative prices of exports vs. imports).
– Example: A country exports goods where it has a comparative advantage and
imports others, improving overall welfare.
• Limitation: Assumes simplified economic conditions and ignores dynamic factors
like technology changes.
2.2.4 Competitive Advantage (Michael Porter, 1990)
• Overview: Focuses on how firms and nations gain a competitive edge in global
markets through innovation, strategy, and industry structure.
• Key Points:
– Based on Porters Diamond Model: factor conditions, demand conditions, re-
lated/supporting industries, and firm strategy/rivalry.
– Emphasizes innovation, branding, and quality over cost alone.
– Example: Japans competitive advantage in electronics due to skilled labor,
strong domestic demand, and innovative firms.
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– Governments can support through policies (e.g., R&D incentives).
• Limitation: Firm-level focus may not fully explain national trade patterns.
