Question

According to the following trade models, how do countries decide on what to produce and export (or specialize) to the world market?

i. Absolute Advantage

ii. The Ricardian Model

iii. The Specific-Factors Model

iv. Hecksher-Ohlin Theory

v. The Old-New Trade Model (Alternative Trade theory)

Answer 1

i. Absolute Advantage : Absolute advantage theory is developed by Adam smith. According to Adam smith a nation will focus on producing and export of a commodity on which it has absolute advantage to produce ( a commodity which required fewer inputs to produce than other nations) and import a commodity which has absolute disadvantage ( a commodity which required more inputs to produce than other nations . It will increase the output of commodities of both nations and they can reap profit and gain from specialization and international trade . ii. The Ricardian model This theory is introduced by David Ricardo. It is based on labor theory of value. According to Ricardian model, if a nation is less efficient in production of both commodities, there is still basis for mutually beneficial trade . The first nation should specialize the production and export of a commodity which has a comparative advantage (absolute disadvantage is smaller) and import a commodity which has comparative disadvantage (absolute disadvantage is higher ) iii. Specific factors model In order to examine the specific factors model. suppose a nation is labor abundant nation and produces two commodities , Commodity X that is labor intensive commodity and commodity Y is capital intensive. Both commodities are produced with labor and capital , labor is mobile between two industries but capital is specific to each industry. With the opening of trade , the nation will specialize in the production of and will export commodity X ( labor intensive commodity ) and import commodity Y ( the specific capital intensive commodity ) iv. Heckscher -Ohlin model According to Heckscher -Ohlin model, a nation will export a commodity whose production requires the intensive use of nation's relatively abundant cheap factor and import a commodity whose production requires the intensive use of nation's scarce and expensive factor. H-O theory isolates the difference in physical availability and supply of factors of production among nation because of relative price of commodities v. The Old -New trade model is also called Product life cycle theory . Product life cycle model has five stages .In first stage ,a product is produced and consumed only in the innovating country . In stage II ,product growth phase time, production is perfected in the innovating country and increase rapidly to accommodate rising demand at home and abroad . In stage III, product maturity phase ,the product become standardized and imitating country starts producing product . In stage IV the imitating country , facing lower labor costs and no longer requires development skill and engineering skill . In stage V, imitating country undersell the innovating country in their market as well and production of product in the innovating county declines