INTERNATIONAL THEORY
[Link] SANCHETI
DIVYA
SATIYAPRAKESH
In this chapter we are going to study, using
Classical theory of international trade, how and
whynations trade.
Chapter 3
Classical Theory is useful because:
1-- The theory is applicable to today's world
in the sense that it explains why and how trade
is beneficial to all
Classical Theory is useful because:
1-- The theory is applicable to today's world in the sense that it
explains why and how trade is beneficial to all
2-- The theory explains why and how a high
cost (wage) country like U.S. could export to a
low cost (wage) country like Mexico.
Classical Theory is useful because:
1-- The theory is applicable to today's world in the sense that it
explains why and how trade is beneficial to all
2-- The theory explains why and how a high cost (wage) country
like U.S. could export to a low cost (wage) country like Mexico.
3-- The theory shows why specialization in
necessary.
Classical theory of international trade
covers:
Absolute advantage theory of Adam Smith
Comparative advantage theory of David
Ricardo. Some argue that Robert Thorrens
had first discovered the Comparative
Advantage theory in 1808
New Assumptions
Factors of production are not mobile among
countries.
New Assumptions
Factors of production are not mobile among countries.
There are no barriers to trade.
New Assumptions
Factors of production are not mobile among countries.
.
There are no barriers to trade
Imports are paid by exports. Balance of
trade and no borrowing.
New Assumptions
Factors of production are not mobile among countries.
There are no barriers to trade.
Imports are paid by exports. Balance of trade and no borrowing.
Labor is the only factor of production in
terms of productivity analysis and cost of
production.
Absolute Advantage : Adam Smith
Wealth of Nations, 1776
His theory of international trade was very
simple and was based on the principle of:
-- self interest
Absolute Advantage : Adam Smith
Wealth of Nations, 1776
His theory of international trade was very simple and was
based on the principle of:
-- self interest
-- specialization
Absolute Advantage : Adam Smith
Wealth of Nations, 1776
His theory of international trade was very simple and was
based on the principle of:
-- self interest
-- specialization
-- competition
Absolute Advantage : Adam Smith
Wealth of Nations, 1776
His theory of international trade was very
simple and was based on the principle of:
-- self interest
-- specialization
-- competition
Absolute Advantage : Adam Smith
Wealth of Nations, 1776
all of the three principles lead to one thing,
the absolute advantage.
Absolute Advantage : Adam Smith
Wealth of Nations, 1776
all of the three principles lead to one thing, the absolute
[Link] though he started with the
example of a pin factory in which workers
cooperate and specialize to make pins, he
argued that this is applicable to international
trade as well.
Absolute Advantage : Adam Smith
Wealth of Nations, 1776
all of the three principles lead to one thing, the absolute
advantage. Even though he started with the example of a pin
factory in which workers cooperate and specialize to make pins,
he argued that this is applicable to international trade as well.
He argued that if all countries specialize,
they can increase production of whatever
they were producing, and sell the extra to
other countries.
The Principle of Absolute
Advantage
“If a foreign country can supply us with a
commodity cheaper than we ourselves can make
it, better buy it of them with some part of the
product of our own industry, employed in a way
in which we have some advantage” Wealth
of Nations, Adam Smith
What is Real Cost?
According to Adam Smith, “real cost” is the amount of labor
time required to produce a commodity.
Based on the labor theory of value
Treats labor as the only factor of production & holds that
commodities exchange for one another in proportion to the
number of hours required for their production
Example:
Given 10 hours of labor to produce 1 shirt & 40 hours of labor to
produce 1 pair of shoes
The labor in producing 4 shirts = Labor in producing 1 pair of
shoes
This argument holds for any given market area within which labor
can move freely from one industry to another and one place to
another (i.e. within a single country)
Problems arise in exchange between countries due to legal &
cultural restrictions
An example of Absolute Advantage
between Two Countries
Days of Labor Required Country
to Produce Italy Scotland
Wine (1 barrel) 20 120
Cloth (1 bolt) 100 30
Which has absolute advantage in Wine?
Which has absolute advantage in Cloth?
An example of Absolute Advantage
between Two Countries
In the absence of trade,
In Italy, 1 bolt of cloth exchanges for 5 barrels of wine (1c = 5w)
or I barrel of wine exchanges for 1/5 bolt of cloth (1w = 1/5c)
In Scotland, 4 bolts of cloth exchanges for 1 barrel of wine (1w =
4c) or I bolt of cloth exchanges for ¼ barrel of wine (1c = ¼ w)
By shifting 120 days of labor from wine to cloth, Scotland could
produce four additional bolts of cloth, worth 4 barrels of wine
from Italy.
By shifting 100 days of labor from cloth to wine, Italy could
produce five additional barrels of wine, worth 5 bolts of cloth from
Scotland.
Therefore, Italy has the clear absolute advantage in wine and
Scotland in cloth (lower real cost)
Thus, Specialization
Each country produces what it is best at and trades for what it is
not so good at producing
Where is Absolute Advantage the
Best Route?
Brazil produces coffee at a lower real cost
than Germany
Florida produces orange juice at a lower
real cost than Iceland
Australia produces wool at a lower real cost
than Switzerland
However, the drawback to absolute
advantage is that it is very restrictive.
What if a nation (or an individual) does not
have an absolute advantage in any line of
production?
