Ch 5 Notes

Ch 5 Notes - Chapter 5: International Trade Theories...

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Chapter 5: International Trade Theories Mercantilism advocated that countries should simultaneously encourage exports and discourage imports. Adam Smith’s theory of absolute advantage was proposed in 1776. This theory was the first to explain why unrestricted free trade is beneficial to a country. Free trade refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country, or what they can produce and sell to another country. Smith argued that the invisible hand of the market mechanism, rather than government policy, should determine what a country imports and what it exports. The theories of Smith, Ricardo and Hecksher-Ohlin go beyond the ‘common sense’ notion (which suggests that some international trade is beneficial), to show why it is beneficial for a country to engage in international trade even for products it is able to produce for itself. The gains arise because international trade allows a country to specialize in the manufacture and export of products that can be produced most efficiently in that country, while importing products that can be produced more efficiently in other countries. These theories also help to explain the pattern of international trade that we observe in the world economy. Some patterns are easy to explain, such as weather conditions yet some are more difficult to explain. David Ricardo’s theory of comparative advantage offers an explanation in terms of international differences in labour productivity. The more sophisticated Heckscher-Ohlin theory emphasizes the interplay between the proportions in which the factors of production are available in different countries and the proportions in which they are needed for producing particular goods. One early response to the failure of the Heckscher-Ohlin theory to explain the observed
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Ch 5 Notes - Chapter 5: International Trade Theories...

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