2. Trade
Trade refers to exchange of goods & services between
seller & buyer
Trade is of 2 types i.e. Domestic trade & International
Trade
Domestic Trade is carried out within the country &
international trade refers to trade between countries
3. Similarities in Domestic & International
Trade
Both involve exchange of goods & services
Objective is Profit Maximization
Basis for trade is cost advantage
Both enhance consumer’s satisfaction by providing
various goods & services
4.
5. Comparative Cost Advantage Theory of
International Trade
According to David Ricardo, countries will export
products where they have cost advantage & surplus
production
They will import goods where they have cost
disadvantage
This theory is based on labour value i.e. Value of goods
depends upon amount of labour used to produce it
6. Comparative Cost Advantage Theory of
International Trade
Assumptions for Cost Advantage Theory
Labour is the only factor of production & is homogenous factor
Cost of production of all commodities are measured in terms of
labour cost
Labour is perfectly mobile within country but immobile between
countries
Economy is Laissez-Faire i.e. No govt intervention
Free Trade (Absence of Tariffs, Quotas etc.)
Perfect Competition prevails in both countries
Transport cost are ignored
Full employment in both countries
7. Comparative Cost Advantage Theory of
International Trade
Ricardo explained this theory by using 2 country – 2
commodity & 1 factor of production model
When both the countries do not have trade relations then
both the items will be produced by each country & 1 good
will be exchanged for other
This is known as domestic exchange rate
Countries No. Of Hours to produce 1 Unit
Wine Cloth
Portugal 80 90
England 120 100
8. Comparative Cost Advantage Theory of
International Trade
For Portugal, 1 unit of wine = 0.88 units of cloth
For England, 1 unit of wine = 1.2 units of cloth
When trade takes place, 1 unit of wine will range from 0.88
units to 1.2 units of cloth
Portugal would like to get more than 0.88 unit of cloth for
every unit of wine sold (as 0.88 is their own price)
England would like to give less than 1.2 unit of cloth for
every unit of wine purchased (as 1.2 is their own price)
Assuming, exchange ratio is 1 unit of wine = 1 unit of cloth,
then both the countries will benefit
9. Comparative Cost Advantage Theory of
International Trade
When countries specialize & trade, production of goods
will be more
If there was no trade then both the countries would be
producing both the products and having less benefit
with more of labour hours
Thus according to this theory, differences in comparison
cost advantage leads to international trade
10. Critical Evaluation
Based on 2 country, 2 commodity & 1 factor model – restrictive in
nature
Based on Labour value theory, which is unrealistic
Full employment, Perfect Mobility etc. are not tenable
assumptions
Only 1 factor of Labour is considered & others are ignored – Not
comprehensive
Partial theory as emphasises only on supply and ignorant about
demand
No proper Exchange rate
11. Heckscher – Ohlin Theory of Int.
Trade
This theory is also known as factor endowment theory
Comparative cost advantage theory only explained that
int. trade took place due to cost differences
However they did not explain the reasons for cost
differences
This theory explains the reasons for cost differences
Modern theory starts where cost comparative theory
ends
12. Heckscher – Ohlin Theory of Int.
Trade
As per this theory, cost difference arises due to 2 reasons
Different countries have different factor endowments
Factor proportions used for producing commodities are
different in different countries
13. Heckscher – Ohlin Theory of Int.
Trade
Assumptions
2 country, 2 commodity & 2 factor model
1 country is endowed with abundance of labour & other with capital
Free Trade (Absence of Tariffs, Quotas etc.)
Full employment in both countries
Perfect Competition prevails in both product & factor market
Factors of Production are perfectly mobile within country but
immobile between countries
No Transportation cost
Factors of Production are homogenous in both the countries
14. Heckscher – Ohlin Theory of Int.
Trade
As per this theory, countries will specialize in
production of those products which uses the abundant
factor (labour / Capital)
Viz, capital rich country will specialize in capital
intensive goods & labour abundant country will
produce more of labour intensive products & export
This is so, as abundant factor is available easily & at
cheaper rates
15. Advantages of International
Trade
Comparative Cost Advantage
Specialization
Optimum use of Resources
Benefit to Consumer
Increase in Production, Employment & N.I.
Availability of Goods & Services
Conservation of Scarce Resources
Promotion of Inter-Dependence & Co-Operation
16. Questions
1. Explain Trade – Distinguish between Domestic &
International Trade
2. Explain Comparative Cost Advantage Theory
3. Explain Heckscher – Ohlin Theory of International
Trade
4. Discuss the various benefits of International Trade
