Part 2 - International Trade
Chapter 1 – Why Does International Trade Matter
Theory of international trade timeline
1500-1700 Mercantilism
Adam Smith’s absolute advantage
Absolute advantage and labour costs
Absolute advantage in everything
1800’s Ricardian theory of trade
-David Ricardo’s comparative advantage theory
-Assumptions :1. A two-country and two-commodity model is applied.
2. Labour is the only factor of production, homogeneous and mobile within a
country but immobile between countries.
3. Technology does not change (no innovation)
4. There is full employment in both countries before and after the trade
5. Perfect competition prevails in all markets
6. Constant returns to scale
7. Free Trade: no restrictions on imports or exports
8. No transport costs
-Comparative advantage : the advantage that one country has over another if they can
producte a product at a lower opportunity cost than another country
-Opportunity cost : value of one product in terms of another e.g. the quantity of food that
must be sacrificed to produce one more unit of clothing
1900’s Factor endownment theory
-Heckscher-Ohlin theory
-Assumptions :1. Two country and two commodity model applies
2. Two factors of production, capital(K) and labour (L) that are mobile across
sectors
3. Perfect competition prevails in all markets
4. Free Trade: no restrictions on imports or exports
5. Constant returns to scale
6. Countries have identical production technologies
7. Consumer tastes are the same across countries, and preferences for
commodities do not vary with a country’s level of income.
Chapter 1 – Why Does International Trade Matter
Theory of international trade timeline
1500-1700 Mercantilism
Adam Smith’s absolute advantage
Absolute advantage and labour costs
Absolute advantage in everything
1800’s Ricardian theory of trade
-David Ricardo’s comparative advantage theory
-Assumptions :1. A two-country and two-commodity model is applied.
2. Labour is the only factor of production, homogeneous and mobile within a
country but immobile between countries.
3. Technology does not change (no innovation)
4. There is full employment in both countries before and after the trade
5. Perfect competition prevails in all markets
6. Constant returns to scale
7. Free Trade: no restrictions on imports or exports
8. No transport costs
-Comparative advantage : the advantage that one country has over another if they can
producte a product at a lower opportunity cost than another country
-Opportunity cost : value of one product in terms of another e.g. the quantity of food that
must be sacrificed to produce one more unit of clothing
1900’s Factor endownment theory
-Heckscher-Ohlin theory
-Assumptions :1. Two country and two commodity model applies
2. Two factors of production, capital(K) and labour (L) that are mobile across
sectors
3. Perfect competition prevails in all markets
4. Free Trade: no restrictions on imports or exports
5. Constant returns to scale
6. Countries have identical production technologies
7. Consumer tastes are the same across countries, and preferences for
commodities do not vary with a country’s level of income.
