Theories of International trade

Mercantilism weakens a country Free trade increase countries wealth Enables to provides variety of good and services.

Theory of Absolute Cost Advantage

Theory of Absolute cost advantage Theory of International Trade (1776) Based on Labour Division Skilled labour Specialization Advantage Countries have absolute cost advantage due to following reasons Suitability of skills Specialization of labour Economies of scale would reduce lanbour cost Natural Advantage Acquired Advantage: Inaddition to skilled labour, trough technology E g-Japan.

Assumptions:
Trade between two countries Only two comodites are traded Free trade exists between countries The only element of cost of production is labour

EG
Output per one day of labour Japan Pens Tape recorder
24

India 48 4

Japan needs 48 pens and India needs 8 Tape recorders. Individually - 2 days for each country to manufacture without trade if Japan and India agree to trade: Concentrating on their absolute advantage Japan will take 1 day to produce 8 tape recorder. And India will take 1 day to produce 48 pens Saving 1 day of labour .

Implications OF Absolute Cost Advantage Theory Quantities of both the products. Increase in Living standards Inefficiency in producing certain products could be avoided. Global labour productivity and other productivity could be maximized.

Limitations: Variety of resources Scale Production Transport cost Absolute advantage of many product No absolute advantage : one country should be able to produce at least on product at a comparatively low cost. But, in reality , most of the developing countries do not have absolute advantage of cost still they participate in international trade

COMPARATIVE COST ADVANTAGE THEORY

David Ricard British economist- explained the Absolute cost advantage theory to clarify this situation and develop the Theory of comparative cost Advantage.

Assumptions of the Theory: There exists full employment The only element of cost of production is labour. Production is subject to the law of the constant Returns. There are no trade barriers. Trade is free from the cost of production Trade takes place between two countries Only two prduct are traded. Thare are no cost of transport.

Example of theory of comparative cost advantage.

Out put per one day of labour Japan Pens Tape recorder 72 8 India 64 2

one day of labour consists of 8 hrs of work Japan- 9pens/hr & 1 TR/hr India - 8pens/hr & 0.25 TR/hr i.e 1 Tr in 4 hrs Both the products Japan has absolute cost advantage Japan is 2 times 1.2 times better than India in production TR & in pen Alternatively India is only 0.25 as good as Japan in TR production but 0.83 in pen production

The cost of labour required to produce 1 tape recorder is 4 hrs of labour work in which India can produce 32 pens 1 tape recorder = 32 pens Whereas for Japan its 1hours of labour work .i.e 1 tape recorder(TR) = 9 pens trade 2 TR for 32 pens .ie 1 TR= 16 pens. Which India could produce in 4 hr(32 pens) and Japan could produce in 2 hrs ( 2 Tr) Thus India increasing the productivity of TR from 2 to 3 Tr or 2 TR + 4hrs of Labour work to produce pens And Japan Could now have 80 pens (32+48pens) increasing its productivity of pens or 72 pens + 1 hrs of labor work. Implications: Effecient allocation of Global Resources Maximization of Global production with least Cost It is better for countries to specialize in those products which they relatively do best. Demand for resources and product nationwide would be optimized.