Introduction of International Trade

The exchange of goods or services along international borders. This type of trade allows for a greater competition and more competitive pricing in the market. The competition results in more affordable products for the consumer. The exchange of goods also affects the economy of the world as dictated by supply and demand, making goods and services obtainable which may not otherwise be available to consumersglobally.

International trade touches us all. We drink soda from cans made of aluminum mined in Australia, wear shoes made in Europe, eat fruit from South America, build machinery from steel milled in Asia, wear clothes made from African cotton, and live in homes built from North American wood sip tea from India. We take it for granted, yet before we can enjoy these products and materials, traders must negotiate prices and deliver the goods through a network of relationships that literally spans the globe.

Theories of International Trade

Mercantilism
Mercantilism is the economic theory holding that the prosperity of a nation depends upon its supply of capital and that the global volume of trade is unchangeable. The amount of capital, represented by bullion (amount of precious metal held by the state), is best increased through a balance of trade with large exports and low imports. Mercantilism suggests that the government should advance these goals by playing an active, protectionist role in the economy by encouraging exports and discouraging imports, especially through the use of tariffs. The economic policy based on these ideas is often called the mercantile system.1

Introduction of Mercantilism
Mercantilism is an economic concept which believes that the wealth of a nation could only be achieved through governmentcontrols and regulation of trade, commerce and economic activities. It was an economic system that was practised in the 16th to 18th centuries. The underlying principle of mercantilism was to achieve a positive balance of trade (trade surplus) by encouraging exports of home-made products and markedly restricting importation through imposition of tariffs and stringent regulation. Its use was favoured by writers such as Jean-Baptiste Colbert, who at a time served as the French Finance Minister. A classical description of this approach could be seen in a statement contained in the document Discourse in the Common Weal of this Realm of England in 1549, where a warning was put out for England not to impoverish itself and enrich strangers. This, the document stated, could only be achieved by not buying more from them than we sell to them. The end game of this policy was to achieve a situation of wealth by increasing the amount of gold and silver trading in the mercantilist nations treasury, and at the same time restricting French finance minister and mercantilist Jean-Baptiste Colbert served for over 20 years.

avenues through which these metals were exported. Mechanisms put in place to achieve this included the prohibition of transactions using these precious metals by private citizens.

Features of a Mercantilist Economy

1) Import prohibition of certain goods using imposition of high tariffs, government legislation or very high taxes/import duties. 2) A wide range of government subsidies on export industries to promote the countrys export-based policy. 3) Policies of nationalism. 4) Accumulation of assets in gold and silver, and prohibition of private accumulation, use or export of these items. 5) One-way trade with colonies, and importation of gold and raw materials from these sources. A negative effect of mercantilism was that it encouraged plenty of warfare, since the only way open to get wealth that could not be obtained by trade was to forcefully take it from another country. Conquered territories were made to pay hefty tributes in gold and had their natural resources plundered. Many analysts are also quick to point out that the colonization of territories like Africa and what constitutes Latin America and the West Indies can also be likened to a form of mercantilism. Mercantilism in todays global economy Mercantilism was severely opposed by core capitalist proponents such as Adam Smith and Dave Ricardo, who were proponents of free trade or laissez-faire economic systems of trade. Even though the late 18th century is regarded widely as a period when mercantilism fell out of favour, critics are quick to point out that countries like Japan that rely heavily on exports for their revenue and which has taken steps like currency devaluation to achieve this aim, are indeed, practising a modern form of mercantilism. China is another country where modern-day mercantilism is flourishing. After the declaration by Deng Xiaoping to his countrymen in the 80's that to get rich is glorious, the Chinese government led an industrial revolution that involved the setting up of industries to produce just about anything that could be produced, and exporting same to markets in the Americas, Europe and Africa. Combined with a deliberate government policy of a fixed exchange rate for the Chinese Yuan, which has effectively kept the currency permanently undervalued when compared to Western currencies, the governments exports have largely accounted for its $ 1 trillion foreign reserves and its massive trade surplus. Today, the US is one of Chinas biggest debtors. Negotiations to get the Chinese government to open up its markets to foreign goods are yet to yield the desired results.

We have also seen failed attempts at mercantilism by countries like Nigeria which are primarily import oriented, but which still have several import prohibitions without a concurrent increase in the production capacity of export-oriented industries to balance the equation.

Definition of 'Mercantilism' The main economic system used during the sixteenth to eighteenth centuries. The main goal was to increase a nation's wealth by imposing government regulation concerning all of the nation's commercial interests. It was believed that national strength could be maximized by limiting imports via tariffs and maximizing exports. Definition of 'Mercantilism' Body of economics thought popular during the mid 16th and late 17th centuries. It held that money was wealth, accumulation of gold and silver was the key to prosperity, and one nation's gain was another's loss. Supported by economists such as Gerard de Malynes (1586-1641), Edward Misselden (1608-54), and Sir Thomas Mun (1571-1641) in the UK, Jean Baptiste Colbert (1619-83) in France ,and Antonio Serra in Italy (1570-?), it exhorted governments to maintain surplus of exports over imports through tariffs (duties), colonialism, and other such measures. Mercantilism's demise was initiated by David Hume, Adam Smith (who coined the term), and other classical economist (see Classical Economics) who saw it as serving only the merchant class and argued that real wealth was to be equated with full employment through greater production of goods and services. In more recent times, the mercantilism dogma was revived by the UK economist John Maynard Keynes (1883-1946) when he stated that a surplus in balance-of-trade stimulates demand, thus increasing the national wealth. When corporations, politicians, and unions demand control over imports through higher-duties to protect local jobs and industries, they are resorting to mercantilism. See also laissez faire economics.Investopedia explains 'Mercantilism' This approach assumes the wealth of a nation depends primarily on the possession of precious metals such as gold and silver. This type of system cannot be maintained forever, because the global economy would become stagnant if every country wanted to export and no one wanted to import. After a period of time, many people began to revolt against the idea of mercantilism and stressed the need for free trade. The continued pressure resulted in the implementation of laissez faire economics in the nineteenth century.

Absolute Advantage Theory

When one nation is more efficient than ( or has less absolute advantage over) another in the production of one commodity A; but it is less efficient than (or has an absolute disadvantage over) the other nation in producing a second commodity B. Therefore, both countries can gain by each specializing in the production of the commodity at its absolute advantage where its resources are utilized in the most efficient way.2

The theory that trade occurs when one country, individual, company, or region is absolutely more productive than another entity in the production of a good. A person, company or country has an absolute advantage if its output per unit of input of all goods and services produced is higher than that of another entity producing that good or service.

Introduction to Absolute Advantage theory The Scottish economist Adam Smith developed the trade theory of absolute advantage in 1776. A country that has an absolute advantage produces greater output of a good or service than other countries using the same amount of resources. Smith stated that tariffs and quotas should not restrict international trade; it should be allowed to flow according to market forces. Contrary to mercantilism Smith argued that a country should concentrate on production of goods in which it holds an absolute advantage. No country would then need to produce all the goods it consumed. The theory of absolute advantage destroys the mercantilistic idea that international trade is a zerosum game. According to the absolute advantage theory, international trade is a positive-sum game, because there are gains for both countries to an exchange. Unlike mercantilism this theory measures the nation's wealth by the living standards of its people and not by gold and silver.

There is a potential problem with absolute advantage. If there is one country that does not have an absolute advantage in the production of any product, will there still be benefit to trade, and will trade even occur? The answer may be found in the extension of absolute advantage, the theory of comparative advantage.

Origin of the theory The main concept of absolute advantage is generally attributed to Adam Smith for his 1776 publication An Inquiry into the Nature and Causes of the Wealth of Nations in which he countered mercantilist ideas. Smith argued that it was impossible for all nations to become rich simultaneously by following mercantilism because the export of one nation is another nations import and instead stated that all nations would gain simultaneously if they practiced free trade and specialized in accordance with their absolute advantage. Smith also stated that the wealth of nations depends upon the goods and services available to their citizens, rather than their gold reserves. While there are possible gains from trade with absolute advantage, the gains may not be mutually beneficial. Comparative advantage focuses on the range of possible mutually beneficial exchanges.
Example 1[edit source | editbeta]

Party B has the absolute advantage.

Party A can produce 5 widgets per hour with 3 employees. Party B can produce 10 widgets per hour with 3 employees.

Assuming that the employees of both parties are paid equally, Party B has an absolute advantage over Party A in producing widgets per hour. This is because Party B can produce twice as many widgets as Party A can with the same number of employees.

Example 2[edit source | editbeta]

You and your friends decided to help with fundraising for a local charity group by printing t-shirts and making birdhouses. Scenario 1: One of your friends, Gina, can print 5 t-shirts or build 3 birdhouses an hour. Your other friend, Mike, can print 3 t-shirts an hour or build 2 birdhouses an hour. Because your friend Gina is more productive at printing t-shirts and building birdhouses compared to Mike, she has an absolute advantage in both printing t-shirts and building birdhouses. Scenario 2: Suppose Gina wasn't as agile with the hammer and could only make 1 birdhouse an hour, but she took a sewing class and could print 10 t-shirts an hour. Mike on the other hand takes

woodworking and so he can build 5 birdhouses an hour, but he doesn't know the first thing about making t-shirts so he can only print 2 t-shirts an hour. While Gina would have the absolute advantage in printing shirts, Mike would have an absolute advantage in building birdhouses.

Referances

1 -http://stormnutt.tripod.com/ 2 -inInternational Economics, Dominick Salvatore,pp37-39)(Ref:Lecture Note Week 1)