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International Business
Rakesh Mohan Joshi
Professor & Chairperson, IIFT New Delhi

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ational Business
R. M. Joshi

Chapter 2: Theories of
International trade

Chapter 2

THEORIES OF
INTERNATIONAL
TRADE

Copyright @ Oxford University Press Intern

ational Business
R. M. Joshi

Chapter 2: Theories of
International trade

Learning Objectives

To discuss the implications of trade theories on

international business
To explain various theories of international trade
To examine gains from trade under various trade
theories
To explain the theoretical framework for shifting
patterns of production and trade

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Chapter 2: Theories of
International Trade

Implications of Trade Theories

Trade theories provides the conceptual base for international trade
and shifts in trade patterns. They also facilitate in understanding the
basic reasons behind the evolution of a country as a supply base or
market for specific products.

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Chapter 2: Theories of
International Trade

Theory of Mercantilism
The theory attributes and measures the wealth of a
nation by the size of its accumulated treasures. It aims
at accumulating financial wealth in terms of gold by
encouraging exports and discouraging imports.

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Chapter 2: Theories of
International Trade

Theory of Absolute Advantage

Absolute advantage may be defined as ability of a nation to produce the
goods more efficiently and cost effectively than any other country.
According to the theory, each country should specialize in producing
those goods that it can produce more efficiently, instead of producing all
products. Thus, a country should use increased production to export and
acquire more goods by way of imports which in turn would improve
living standards of its people.
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Chapter 2: Theories of
International Trade

Theory of Comparative Advantage

Comparative Advantage may be defined as the inability of a nation to produce a
good more efficiently than other nations, but its ability to produce that good
more efficiently compared to the other good.
Thus, the country may be at an absolute disadvantage with respect to both the
commodities but the absolute disadvantage is lower in one commodity than
another. Therefore, a country should specialize in the production and export of
a commodity in which the absolute disadvantage is less than that of another
commodity or in other words, the country has got a comparative advantage in
terms of more production efficiency.
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Chapter 2: Theories of
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Revealed Comparative Advantage

It is measured by a countrys share of world exports of a commodity
divided by its share in total exports.
RCAij = (Xij/Xwj)/(Xi / Xw)
Where
Xij = ith country export of commodity j
Xw = world exports of commodity j
Xi = total exports of country i
Xw = total world exports

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Chapter 2: Theories of
International Trade

Factor Endowment
(Hecksher-Ohlin) Theory
A nation will export the goods whose production requires
intensive use of the nations relatively abundant and cheap factors
and import the goods whose production requires intensive use of
its scarce and expensive factors.

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Chapter 2: Theories of
International Trade

The Leontief Paradox

Wassily Leontief carried out an empirical test of the
Heckscher-Ohlin Model in 1951 and found that the US
exported more labour-intensive commodities and
imported more capital intensive products which was
contrary to the results of Heckscher-Ohlin Model of
factor endowment.

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Chapter 2: Theories of
International Trade

Country Similarity Theory

Trade occurs between nations that have similar
characteristics, such as economic, geographic, cultural,
etc. However, in case of manufactured goods, cost was
determined by similarity in product demands across
countries rather than by relative production costs or
factor endowments
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Chapter 2: Theories of
International Trade

The New Trade Theory

The theory elucidates that international trade enables a firm
to increase its output due to specialization by providing
larger markets, resulting into enhancing its efficiency. It
helps explain the trade patterns when markets are not
perfectly competitive or when economies of scale are
achieved by production of specific products.

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Chapter 2: Theories of
International Trade

International Product Life Cycle Theory

The theory explains the variations and
reasons for change in production and
consumption

pattern

among

various

markets over a time period.

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Chapter 2: Theories of
International Trade

Stages of International Product Life Cycle

The IPLC has four distinct identifiable stages that
influences demand structure, production, marketing
strategy, and international competition as follows:
Stage 1: Introduction

Stage 2: Growth

Stage 3: Maturity

Stage 4: Decline

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Chapter 2: Theories of
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Theory of Competitive Advantage

According to the theory, a firms home country environment is
the main source of competencies and innovations often referred
to as the diamond mode, it focuses upon the four determinants:
Factor (Input) Conditions
Firm Strategy and Rivalry
Demand Conditions
Related and Supporting Industries

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Chapter 2: Theories of
International Trade