1.
THEORIES OF INTERNATIONAL TRADE
An Overview of International Trade and
International Trade Theory
Joseph Owusu,PhD

2.
Learning Objectives
 Understand why nations trade with each other
 Discuss how distance and borders reduce trade.
 Describe how the value of trade between any two
countries depends on the size of these countries’
economies and explain the reasons for that relationship.

3.
Introduction
What is international trade?

4.
International Trade Defined.
 International trade is the exchange of
goods and services as well as resources
between countries.
 It involves transactions between residents
of different countries.

5.
Why nations engage in International trade?
 Economic view: there must be economic gains
from trade from both sides in trade
 Resource based view: some nations have unique
resources to create exports (goods and services)
that are unique to imitate.
 Institution view: nations have different rules that
govern trade which determine gains that are
shared among nations.

6.
Importance of international free trade
The absence of restrictions to the flow of goods and services
among nations.
Free trade is usually best because:
Consumers and firms can buy the products they want.
Imported products may be cheaper than domestically
produced products
Lower-cost imports help reduce business costs, thereby
raising company profits
Lower-cost imports help consumers save money, thereby
increasing their living standards
Unrestricted international trade tends to increase the overall
prosperity of nations.

7.
Who Trades with Whom?

8.
Economic size Matter
 Three of the top 15 U.S. trading partners are European nations:
Germany, the United Kingdom, and France.
 Why does the United States trade more heavily with these three
European countries than with others?
 The answer is that these are the three largest European economies.
That is, they have the highest values of gross domestic product
(GDP), which measures the total value of all goods and services
produced in an economy.
 There is a strong empirical relationship between the size of a country’s
economy and the volume of both its imports and its exports.

9.
Impediments to Trade: Distance, Barriers,
and Borders
 Canada and Mexico. As you can see, the two neighbors of the United
States do a lot more trade with the United States than European
economies of equal size.
 In fact, Canada, whose economy is roughly the same size as Spain’s,
trades as much with the United States as all of Europe does.
 Why does the United States do so much more trade with its North
American neighbors than with its European partners?
 The main reason is the simple fact that Canada and Mexico are much
closer.

10.
The Changing Pattern of International Trade
 The direction and composition of international trade
is quite different today from what it was a
generation ago and even more different from what it
was a century ago. Let’s look at some of the main
trends.

11.
Has the World Gotten Smaller? 1of2
 Modern transportation and communications have
abolished distance, so that the world has become a small
place.
 The Internet makes instant and almost free
communication possible between people thousands of
miles apart, while jet transport allows quick physical
access to all parts of the globe.

12.
Has the World Gotten Smaller? 2of2
 Due to advances in transportation and telecommunications
technology barriers to cross-border trade and investment
are declining.
 We are moving toward a world in which national economies
are merging into an interdependent and integrated global
economic system.
 E.g. In today’s interdependent global economy, an
American might drive to work in a car designed in Germany
that was assembled in Mexico by Ford from components
made from Korean steel and Malaysian rubber.

13.
What do we Trade?
 When countries trade, what do they trade?
 Manufactured goods: such as automobiles, computers, and clothing
to each other.
 Mineral products—a category that includes everything from copper
ore to coal, but whose main component in the modern world is oil—
remains an important part of world trade.
 Agricultural products-- such as wheat, soybeans, and cotton are
another key piece of the picture, and
 Services of various kinds play an important role and are widely
expected to become more important in the future. E.g. traditional
transportation fees charged by airlines and shipping companies,
insurance fees received from foreigners, and spending by foreign
tourists.

14.
Arguments in support and against international trade
Support
 Reduction in domestic
monopoly
 Economic growth and rising
income
 Inputs at competitive prices
 Supply of goods during natural
calamities
 Generating employment and
rising standard of living
 Strengthen bonds between
nations
 Contribute to human resource
development
 Enhance efficiency and
profitability
Against
 Rivalry on account of severe
competition
 Depletion of natural resources
 Threats to the survival of
domestic companies
 Loss of cultural identity
 Harmful imports will damage
the environment and health
 Low demand for unskilled and
semi skilled workers
 Risk of trade embargoes

15.
An overview of International Trade Theory
 What Is International Trade Theory?
 International trade theories are simply different theories
to explain international trade. Trade is the concept of
exchanging goods and services between two countries.
 The aim of Trade Theory is to explain
 Trade theory explains why nations trade and the benefits
they stand to gain
 Trade theory explains the pattern of trade and distribution
of gains arising from such trade
 Trade theory explains the observe trade and the effect on
the domestic trade

16.
Trade Theories
 Mercantilism
 Propagated in the 16th and 17th centuries, mercantilism
advocated that countries should simultaneously encourage
exports and discourage imports.
 Although mercantilism is an old and largely discredited doctrine,
its echoes remain in modern political debate and in the trade
policies

17.
Trade Theories
 Theory of Absolute Advantage
 Proposed in 1776, Adam Smith’s theory was the first to explain why
unrestricted free trade is beneficial to a country.
 Free trade refers to a situation where a government does not attempt
to influence through quotas or duties what its citizens can buy from
another country, or what they can produce and sell to another country.
 Smith argued that the invisible hand of the market mechanism,
rather than government policy, should determine what a country
imports and what it exports.

18.
Trade Theories
 Building on Smith’s work are two additional theories that we
shall review.
 Theory of Comparative Advantage.
Advanced by English economist David Ricardo.
 Heckscher-Ohlin Theory.
By two Swedish economists, Eli Heckscher and Bertil Ohlin.

19.
The Benefit Of Trade
 The great strength of the theories of Smith, Ricardo, and
Heckscher-Ohlin is that they identify with precision the specific
benefits of international trade.
 These theories go beyond this commonsense notion (exact
benefit between two countries for trading ) however, to show why
it is beneficial for a country to engage in international trade even
for products it is able to produce for itself.

20.
The Benefit Of Trade
 The theories of Smith, Ricardo, and Heckscher-Ohlin tell us
that a country’s economy may gain if its citizens buy certain
products from other nations that could be produced at
home.
 The gains arise because international trade allows a
country to specialize in the manufacture and export of
products that can be produced most efficiently in that
country, while importing products that can be produced
more efficiently in other countries.

21.
The Benefit Of Trade
 Some economist argued that economies are threatened by
imports because of international trade;
 The theories of Smith,Ricardo, and Heckscher-Ohlin suggest
that the economy as a whole is hurt by restricting imports
the reason being that;
 One of the key insights of international trade theory is that
limits on imports are often in the interests of domestic
producers and their employees but not domestic
consumers.

22.
Trade Theory and Government Policy
 Although all these theories agree that international trade is
beneficial to a country, they lack agreement in their
recommendations for government policy.
 Mercantilism makes a crude case for government involvement
in promoting exports and limiting imports.
 The theories of Smith, Ricardo, and Heckscher-Ohlin form part
of the case for unrestricted free trade.
 The argument for unrestricted free trade is that both import
controls and export incentives (such as subsidies) are self-
defeating and result in wasted resources.

23.
Why do nations trade?
What would the world be like without
international trade?

24.
What would the world be like without
international trade? 1 of 2
 Without international trade, most nations would be
unable to feed, clothe, and house their citizens at current
levels.
 Even resource-rich countries like the United States would
suffer greatly without international trade. Some types of
food would become unavailable or very expensive such as
Coffee and sugar would be luxury items.
 Petroleum-based energy sources would dwindle. Vehicles
would stop running, and people would not be able to heat
their homes in winter.

25.
What would the world be like without
international trade? 2 of 2
In short, not only do nations,
companies and citizens benefit from
international trade, modern life would
be nearly impossible without it.

26.
Answer
 Trade enables countries to use their national resources more efficiently
through specialization. Trade allows industries and workers to be more
productive. These outcomes help keep the cost of many everyday products
low, which translates into higher living standards.
 Without international trade, most nations would be unable to feed, clothe,
and house their citizens at current levels.
 Even resource-rich countries like the United States would suffer greatly
without trade. Some types of food would become unavailable or very
expensive. Coffee and sugar would be luxury items. Petroleum-based energy
sources would dwindle. Vehicles would stop running, freight would go
undelivered, and people would not be able to heat their homes in winter.