INTERNATIONAL TRADETopic-1

Classical&

neo-classicalTheories of i.t

Smith ,recardo,haberler and j.s.mill’s theory.

1.Classical theories of international trade

1.Absolute cost

advantage

theory

1.comparative

cost

advantage

theory

Adam smithDavid Ricardo

2.neo-Classical theories of international trade

1.Opportunity

cost theory

2.Theory of

reciprocal

demand

G.Haberler J.S.Mill

1.Classical theories of international trade

1.Absolute cost

advantage

theory

1.comparative

cost

advantage

theory

Adam smithDavid Ricardo

1.Absolute cost advantage.

Free trade increase the prosperity of the country .

Free trade promote international division of labour.

Free trade make the country specialize in the both

production and exchange.

Each country specialize in the production which can

be produce most cheaply.

Given by Adam Smith

Vent for surplus

When a country produces more then it consumes.

This over production can be utilize by international

trade.

Vent for surplus applicable in UDC’s

It implies international trade is not reversible.

2.Comparative cost advantage.

Given by Devid Ricardo.

Trade is govern under comparative cost advantage.

The country will specialized in the production in

which it has greater comparative advantages in cost

than other country. .

Import from abroad of commodities which has

relatively cost disadvantages..

Acc.to Ricardo there is static condition in the economy.

Labour is only factor of production ..

Supply of factor of production is fixed .

Labour input alone determine the cost producing

commodity.

Two commodity to be exchange b/w two countries.

Trade b/w two countries based on barter system.

Both countries will gain from trade and their cost ratios

are not equal.

Ricardo laid down emphasized on supply conditions..

Theory apply in LDC’s .

Ricardo and Smith’s theory based upon labour theory of

value.s

Law of constant return operate .

Trade indifference curve.

It was developed by Leontief and Lerner.

Finally describe by J.E.Mead in his book Geometry

of international trade..

Trade I.C shows , given level of income countries TOT

exchange neither worse of nor better off.

2.neo-Classical theories of international trade

1.Opportunity

cost theory

2.Theory of

reciprocal

demand

G.Haberler J.S.Mill

1.Opportunity cost theory.

Given by G.Haberler

Haberler reused the comparative cost in terms of

opportunity cost.

opp,cost also called as transformation curve or PPC. By –

Paul Samuelson

Opp.cost means – what has been sacrifice for achieve an

additional unit of other..

There is perfect competition in market.

this is 2*2*2 model.

Price is equal to MC..

He used PPC to explain three conditions.

The slope of PPC called marginal rate of

transformation.

MRTSxy = -

Y

X

The opp. Cost curve may be straight ,convex and

concave depend upon the return to scale. ( constant ,

increasing and decreasing)

1.Constant return to scale.

MRTSxy will constant.

Opp. Cost curve will be straight line.

2.Increasing return to scale..

MRTSxy will decreas..

Y-C

om

m

X-Com

Y-C

om

mX-Com

Opp cost will be decreases.

In this case opp cost and PPC is

negatively sloped.

3.Diminishing return to scale..

MRTSxy will increases...

Opp cost will be increases..

Y-C

om

m

X-Com

In this case opp cost and PPC is

Positively sloped.

The concept of increasing decreasing opp. Cost

and international trade given by –

P.C.Kindelberger.

In this case one portion of PPC is convex and other is

concave.

Theory of reciprocal demand

Given by J.S.Mill.

Offer curve is also called as reciprocal demand curve.

The concept of offer curve originally given by Marshall

and Edgeworth

Mill restate Ricardo's comparative cost in terms of

comparative advantage.

Acc to Mill same amount of labour can yeild different

output in different country.

Reciprocal demand- it is the ratio where two comm.

Transacted ,depend upon strength of elasticity of each

country’s demand.

Assumptions-

2*2*2 model.

Trade is governed by principle of comparative cost.

Demand is same in two countries.

Income of both countries same.

More inelastic the offer curve more favorable will be

TOT.

More elastic offer curve more unfavorable TOT.

Offer curve is determined by demand of the product of

each country.

A2A

A1

B

A’s exportable

B’s

exp

ort

ab

le

T2T

T1

Y

X0

If A’s demand for product Y increases ,

A would willing import more quantity

of Y.

Offer curve of A shift from A to A1.

Volume of trade increases but TOT

becomes unfavorable..

If A’s demand for product Y decreases, A

would willing to import less quantity of

Y.

then offer curve shift from A to A2 .

Volume of trade decreases but TOT

becomes favorable..

A2A

A1

A’s exportable

B’s

exp

ort

ab

le

Y

X0

Offer curve more elastic- shift from A TO

A1.

Offer curve is less elastic – shift from A to

A2.

B1

A

B

A’s exportable

B’s

ex

po

rta

ble

Y

X0

B2 Offer curve more elastic- shift from B

TO B1.

Offer curve is less elastic – shift from B

to B2.

Comparative cost advantage principle was based on

deference b/w productivity of labour.

If demand for foreign product increased then TOT

becomes unfavorable.

If demand for foreign product decreased then TOT

becomes favorable.

Equilibrium exchange rate determine by elasticity of

offer curve.

J.S.Mill emphasized on demand side economy and

neglect supply side.

Two countries size are equal and their value of

commodity also equal.

Size income and demand in both countries are same. .

If one country is large and other is large then….

The gain from trade goes to largely smaller country.

3.modern theories of international trade

Heckscher-Ohlin

theory

Classical vs H-O theory

Neo H-O theory.