Question

Chronicle the development of Trade Theory from the 1500’s to 1919. Be sure to discuss some of the major additions / build-up of the theory.

Answer 1

The Trade Theory is used to explain the existing patterns of trade, the impact on the domestic economy, and the type of public policies that should be introduced to increase a country's well-being.

The barter system is important in age-old practice, used to exchange goods or services among different peoples , probably as old as human history. International trade, however, refers specifically to an exchange between members of different nations, and accounts and explanations of such trade begin only with the rise of the modern nation-state at the close of the European Middle Ages.

As philosophers and political thinkers began to examine the nature and function of the nation, trade with other countries became a particular topic of their inquiry. It is, accordingly, no surprise to find one of the earliest attempts to describe the function of international trade within that highly nationalistic body of thought now known as mercantilism.

The trade theories are divided into two

1.Classical theories( country based)

• Mercantilism
• Absolute advantage( free trade theory)
• Comparative advantage (free trade theory)
• Heckscher - ohlin ( free trade refind)

2.Modern theories( firm based)

• Country similarity
• product life cycle
• Global strategic rivalry
• Porters national competitive advantage

1.Mercantilism.

Mercantilism is the Initial trade theory. that is formed the foundation of economic thought from 1500 – 1800

The main idea of the theory is:

Wealth = GOLD AND SILVER

Exports= increase in wealth

Imports = decrease in wealth

The theory explains that, there is finite amount of wealth in world. It always maintain a favourable trade balance. A nation can only grow rich at the expense of other nations

The main features of mercantilism.

• Promotion of export by providing subsidies
• Import prohibited by rising tariff value
• Accumulation of gold and silver
• Policies of nationalism
• One way trade with colonies

2.Absolute advantage theory

• Adam smith created the theory in 1776
• He criticize the mercantilism theory
• It is created on the basis of foreign trade
• The theory is the exchange of goods will take place only if each of the two countries can produce one commodity at an absolutely lower production cost than the other country
• The theory mainly focus on the ability of a country to produce a good more efficiently than another nattion.

Disadvantages

• Too simplified model
• Labour is mobile  across the borders
• Labour is notHomogeneous in all countries
• The theory didi not consider the existence of Trade barriers
• The theory didi not consider the possibility of unemployment
• The theory neglected the role of capital
• Considered wage as the only production cost

3. Comparative advantage theory

• The theory developed by David Ricardo in 1817
• Export and import concept is

Export = Comparative advantage or low opportunity costs

Import = comparative disadvantage or high opportunity costs

• There are only two countries and they produce two goods
• Labour is the only factor of production and cost of production is measured in terms of labour units.

4.Heckscher ohlin theor

• The theory developed by Eli Heckscher and Bertil Ohlin
• It is also known as factor endownment theory
• The theory mainly focus on how a country could gain comparative advantage by producing products that utilized factors that were in abundance in the country.

Export = Abundant factors

Import = Scare factors

• The theory based on a countrys production factors, like land, labor,capital and enterpreneurship
• Unlike Ricardian Model, the model suggested by Heckscher-Ohlin assumes that there are two factors of production, namely, labor and capital. One country has comparative advantage over the other because of the differences in relative amounts of each factor.