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Questions and Answers
According to mercantilism, a country's wealth is measured by its accumulation of:
Which of the following is an assumption of the absolute advantage theory?
What is the main difference between the absolute advantage theory and the comparative advantage theory?
In the example given in the comparative advantage theory, what is true about Country A?
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What is the main goal of mercantilism?
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What is the primary principle of the Heckscher-Ohlin Theory?
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Which of the following is a key factor that influences international trade according to the Gravity Model?
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What is a consequence of increasing returns to scale, according to the New Trade Theory?
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What is the relationship between the distance between countries and trade, according to the Gravity Model?
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What is a characteristic of firms that can dominate the market, leading to trade, according to the New Trade Theory?
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Study Notes
International Trade Theories
1. Mercantilism (16th-18th centuries)
- Believed that a country's wealth is measured by its accumulation of gold and silver
- Advocated for a positive balance of trade (exports > imports)
- Encouraged export-oriented manufacturing and restrictions on imports
2. Absolute Advantage Theory (Adam Smith, 1776)
- Countries should specialize in producing goods for which they have an absolute advantage (lower production costs)
- Trade allows countries to increase efficiency and productivity
- Examples: Country A can produce 100 units of good X with 10 hours of labor, while Country B can produce 100 units of good X with 20 hours of labor. Country A has an absolute advantage.
3. Comparative Advantage Theory (David Ricardo, 1817)
- Countries should specialize in producing goods for which they have a comparative advantage (lower opportunity cost)
- Trade allows countries to increase efficiency and productivity, even if they don't have an absolute advantage
- Examples: Country A can produce 100 units of good X with 10 hours of labor and 50 units of good Y with 5 hours of labor. Country B can produce 100 units of good X with 20 hours of labor and 50 units of good Y with 10 hours of labor. Country A has a comparative advantage in producing good X, while Country B has a comparative advantage in producing good Y.
4. Heckscher-Ohlin Theory (Eli Heckscher and Bertil Ohlin, 1919)
- Countries will export goods that use abundant factors of production intensively and import goods that use scarce factors intensively
- Examples: A country with an abundance of labor will export labor-intensive goods, while a country with an abundance of capital will export capital-intensive goods.
5. New Trade Theory (1980s)
- Examines the effects of increasing returns to scale, product differentiation, and imperfect competition on international trade
- Firms with increasing returns to scale can lower their average costs by producing more, leading to trade
- Examples: A firm with a unique product can dominate the market, leading to trade.
6. Gravity Model of Trade (Jan Tinbergen, 1962)
- International trade is influenced by the economic size and distance between countries
- Trade between two countries is inversely proportional to the distance between them and directly proportional to their economic sizes (GDPs)
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Description
Understand the fundamental theories that explain international trade, including Mercantilism, Absolute Advantage, Comparative Advantage, Heckscher-Ohlin, New Trade Theory, and the Gravity Model of Trade.
