Sekar Dwi Maulina 6211111054 Chapter Review

Theories of Trade and Economic Development

Introduction To International Trade Theories Theories of international trade attempt to provide explanations for trade motives, underlying trade patterns, and the ultimate benefits that come from trade. And understanding of these basic factor enables individuals, private interest, and government to better determine how to act their own benefit within the trading systems. The major questions to be answered through such an examination trade are: Why does trade occur? Is it because of price differentials, supply differentials, or differences in individual of tastes? What is traded, and what are the prices of terms agreed onin these trading actions? Do trade flows relate to a countrys specific economic and social characteristics? What are the gains from trade, and who realizes these gains? What are the effects of restriction put on trading activity?

Theories of trade have evolved over time, beginning with the emergence of strong nation-states and the organizations of systematic exchange of goods among these nations. Mercantilism Mercantilism was based on the notion that governments should become involved in transfer of goods between nations in the order to increase the wealth of each national entity. The aim is to facilitate and support all exports while limiting imports; these goals were accomplished through the conduct of trade by government monopolies and intervention in the market through the subsidization of domestic exporting industries and the allocation of trading rights. During this period, colonies were acquired to provide sources of raw materials or precious metals. Trade opportunities with the colonies were exploited and local manufacturing was repressed in those offshores locations. The concept of mercantilism incorporates three fallacies; first, the incorrect belief that gold or precious metals have intrinsic values. Second, the theory of mercantilism ignores the concept of production eficiency trough specializations. And the third fallacy of mercantilism concerns the overall goals of the system. If the goal was to maximize wealth from the sale of exports, and if every participating nation had the same aim, the system itself did not promote trade, since all nations cannot maximize exports. Neomercantilism corrected the first fallacy by looking at the overall favorabale or unfavorable balance of trade in all comodities; natios attempted to have a positive balance of trade in all goods produced so that all exports exceeded imports. The term balance of trade continues in popular use today as nation attempt to correct their trade deficit positions by increasing exports or reducing imports so that the outflow of goods balances the inflow. The second fallacy, a disregard for the concept of efficient production, was addressed in subsequent theories, notably the classical theory of trade, which rests on the doctrine of comparative advantage. Subsequent theories also attempted to address the third fallacy.

Classical Theory This theory was based in the economic theory of free trade and enterprise that was evolving at the time. Adam Smith insisted that nations benefited the most when they acquires through trade those goods they could not produce efficiently and produced only those goods that they could manufacture with maximum efficiency. Comparative Advantage The exporting country should look at the relatives efficiencies of production for both commodities and make only those goods it could produce most efficiently.