International Trade Theory Quiz

International Trade Theory

• International trade occurs due to mutual benefits, better quality/lower prices, increased efficiency, competition, and innovation, leading to economic growth. Countries specialize in what they produce most efficiently and trade with each other.
• Example: Canada (oil) and Brazil (coffee) benefit from specialization and trade.

Classical Country-Based Trade Theories

• Focused on countries, explaining trade in commodities.
• Mercantilism (16th-18th Century): Countries sought to maximize exports, minimize imports, accumulating wealth measured in gold and silver. Led to protectionism. Criticized because trade restrictions harm overall efficiency. Modern-day example: trade wars.
• Absolute Advantage (Adam Smith, 1776): A country has absolute advantage when it's more efficient at producing a good than another. Advocates for free trade where countries export what they produce best and import the rest. Example: Canada (wheat) and Japan (electronics).
• Comparative Advantage (David Ricardo, 1817): Trade is beneficial even if one country is more efficient at producing everything; countries should specialize in what they produce at a lower opportunity cost. Example: US (airplanes) and Vietnam (T-shirts). The US has a greater comparative advantage in airplanes, while Vietnam has a comparative advantage in T-shirts.
• Heckscher-Ohlin Theory (Relative Factor Endowments): Countries export goods using their abundant resources and import goods using scarce resources. Example: China (labor-rich) exports textiles, Germany (capital-rich) exports machinery.
  • Leontief Paradox: The U.S., a capital-rich country, exports more labor-intensive goods than capital-intensive ones, contradicting this theory.

Modern Firm-Based Trade Theories

• Focus on firms, not countries.
• Linder’s Country Similarity Theory: Countries with similar income levels often trade similar goods. Explains intra-industry trade—countries exporting and importing similar products. Example: US and Canada trading cars.
• New Trade Theory (Krugman, 1970s): Economies of scale—lower costs as production increases. First-mover advantage—early market entrants gain advantages. Global rivalry—firms compete across borders. Example: Boeing and Airbus in the global aircraft market.

Foreign Direct Investment (FDI)

• Foreign Portfolio Investment (FPI): Buying stocks or bonds abroad.
• Foreign Direct Investment (FDI): Setting up foreign operations.
• Political Factors:
  • Avoiding trade barriers—Companies locate abroad to avoid tariffs.
  • Government incentives—Governments offer incentives to attract investment. Example: Toyota building plants in the US.

Trade and Exchange Rates

• Exchange rates affect import and export prices. Example: Different wage rates in France and Japan, impacting the price of goods traded between them.