3. 4-3
Evolution of Trade Theories
Mercantilism
Absolute advantage (Classical)
Comparative advantage
Factor Proportions Trade
International Product Cycle
New Trade Theory
National competitive advantage
4. 4-4
Mercantilism: mid-16th century
A nation’s wealth depends on accumulated
treasure
Gold and silver are the currency of
trade
Theory says you should have a trade surplus.
Maximize export through subsidies.
Minimize imports through tariffs
and quotas
Flaw: restrictions, impaired growth
5. 4-5
Defining mercantilism …
… trade theory holding that nations
should accumulate financial wealth,
usually in the form of gold (forget
things like living standards or
human development) by encouraging
exports and discouraging imports
6. 4-6
Theory of absolute advantage
Adam Smith: Wealth of Nations (1776) argued:
Capability of one country to produce more of
a product with the same amount of input than
another country
A country should produce only goods where it
is most efficient, and trade for those goods
where it is not efficient
mong
Trade between countries is, therefore, beneficial
Assumes there is an absolute balance a
nations
7. 4-7
Theory of absolute advantage
… destroys the mercantilist idea since there
are gains to be had by both countries party to
an exchange
… questions the objective of national
governments to acquire wealth through
restrictive trade policies
… measures a nation’s wealth by the living
standards of its people
13. 4-13
Theory of comparative advantage
David Ricardo: Principles of Political Economy (1817)
Extends free trade argument
Efficiency of resource utilization leads to more
productivity
Should import even if country is more efficient in the
product’s production than country from which it is
buying.
Look to see how much more efficient. If only
comparatively efficient, than import.
Makes better use of resources
Trade is a positive-sum game
20. 4-20
Assumptions and limitations
Driven only by maximization of production
and consumption
Only 2 countries engaged in production and
consumption of just 2 goods?
What about the transportation costs?
Only resource – labour (that too, non-
transferable)
No consideration for ‘learning theory’