Basis of Trade

Why Trade Globally?

 …Countries trade with each other on their own, when they do not
have the resources, or capacity to satisfy their own needs and
wants..

 …By developing and exploiting their domestic scarce resources,

countries can produce a surplus, and trade this for the resources they
need.

Having unlimited
human wants
which is required to
be fulfilled in a
limited resources
Why Trade Globally? Cont..

1.Differences in Technology

2. Differences in Resources

3. Differences in Demand

4. Existence of Economies of Scale in production

5. Existence of Government Policies

https://youtu.be/50oiX70Qd5A
Current Global Trends.
 The rise of new global players
Ex:- China, Brazil, India
 The spread of production chains

Ex:- Walmart, Toyota, Unileaver

 The increasing commodity prices

Ex:- Oil prices, Food etc.

 The growing economic interdependence

Ex:-
Trade Theories
 Adam Smith Theory (Absolute Advantage Theory)
“If a foreign country can supply us with a commodity cheaper than we
ourselves can make it, better buy it of them with some part of the
produce of our own industry, employed in a way in which we have
some advantage.”

 David Ricardo Theory (Comparative Advantage Theory)

“countries should specialize in production of goods in which they not
only have an absolute advantage but also a relative advantage over
other countries in order to promote benefits of international trade”.
Adam Smith Theory

 He stated that trade would be beneficial for both the countries if

country A exports the goods, which it can produce with lower cost
than country B and import the goods, which country B can produce
with lower cost than it.

 Example:- Sri Lanka & India / They have 100 laborer's each / Both
countries produce Tea and Coffee.

Country Tea Coffee

Sri Lanka 10 5
India 5 15

Sri Lanka has an absolute advantage of Tea compared to India, And

India has an absolute advantage of Coffee compared to Sri Lanka.
The assumptions taken under this theory’ are as
follows
 There are two countries producing two goods.

 The size of economies of these countries are equal

 There is perfect mobility of factors of production within countries

 Transportation cost is ignored

 Before specialization, country’s resources are equally divided to

produce each good
David Ricardo Theory

 He stated that Comparative advantage is an economic term that

refers to an economy's ability to produce goods and services at a
lower opportunity cost than that of trade partners. A comparative
advantage gives a company the ability to sell goods and services at a
lower price than its competitors and realize stronger sales margins
 Example:- Sri Lanka & India / They have 100 laborer's each / Both
countries produce Tea and Coffee.

Country Tea Coffee

Sri Lanka 30 6
India 35 21

India has an Absolute advantage over Sri Lanka on both the products but on Coffee
India has a more Comparative advantage ( 3.5times than Sri Lanka) than Sri Lanka.
The assumptions taken under this theory’ are as
follows
 There are two countries producing two goods.

 The size of economies of these countries are equal

 There is perfect mobility of factors of production within countries

 Transportation cost is ignored

 Before specialization, country’s resources are equally divided to

produce each good
International Product Life Cycle Theory

According to Ronald Vernon (1965):

 Exports and imports will be related to the stage of the product’s life cycle

 Newly developed products will, at first, be exported by the originating

firm. At a later stage of the product life cycle the firm will look for a
lower cost manufacturing base and import the products back into the
originating market.
 Ex:- Computers in the USA Market
National Competitive Advantage

What makes some countries more competitive than others?

Michael Porter (1990) has explained the critical factors for success in
terms of competitive advantages
He identifies 6 key variables as giving a country a competitive
advantage over other countries:
 demand conditions

 factor conditions

 firm strategies

 related and supporting industries

 government policies

 chance
National Competitive Advantage
National Competitive Advantage