This chapter examines the development of international trade theory from the seventeenth century through the second half of the twentieth century. The main goals of this chapter are to: Outline and critically evaluate the major theories that attempt to explain 1) why nations should engage in international trade and 2) the patterns of international trade; show, via simple examples, the case for free trade and how all countries can benefit from free trade; discuss aspects of international trade that do not fit the theory of trade and find some explanations for their apparent conflict;. | US EU Australia China Chapter 3: International Trade Theory TRADE THEORY Comparative advantage New Trade Theory 3-1 Absolute advantage PORTER’S DIAMOND FACTOR ENDOWMENTS 2 TOPIC PLAN: Mercantilism Absolute advantage Comparative advantage Comparative advantage versus competitive advantage Factor endowments The New Trade Theory Porter’s Diamond 3-2 Mercantilism: mid-16th century A nation’s wealth depends on accumulation of precious metals (. holdings of gold and silver). Theory says you should have a trade surplus. Maximize exports through subsidies. Minimize imports through tariffs and quotas. David Hume (1752): persistent trade surplus will affect the money supply and in the long run close the trade surplus Key problem: “Zero-sum game”. 3 - 3 Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea Theories of International Trade: Absolute Advantage The exporting country holds a superiority in the availability of certain goods. Reasons: Climate,quality of land, and natural resources. Differences in labour, capital, technology and entrepreneurship Beef Computer Printers (tonnes) (units) Australia 800 200 Japan 400 500 • Australia has an absolute advantage in beef, while Japan has an absolute advantage in printers. . 3 -4 Theory of Comparative Advantage David Ricardo (1817) One country has a comparative advantage over another in the production of a certain commodity if its opportunity cost of producing that commodity is lower 5 Alternative production possibilities from 100 units of resources Opportunity Cost and Comparative Advantage Diversified production before trade Production/Consumption The Theory of Comparative Advantage and the Gains from Trade Cheese (tonnes) Cloth (bolts) Production and Consumption without Trade Australia 125 60 . 40 60 Total production 165 120 Production with Trade Specialization Australia 200 - - 120 Total production 200 120 Consumption | US EU Australia China Chapter 3: International Trade Theory TRADE THEORY Comparative advantage New Trade Theory 3-1 Absolute advantage PORTER’S DIAMOND FACTOR ENDOWMENTS 2 TOPIC PLAN: Mercantilism Absolute advantage Comparative advantage Comparative advantage versus competitive advantage Factor endowments The New Trade Theory Porter’s Diamond 3-2 Mercantilism: mid-16th century A nation’s wealth depends on accumulation of precious metals (. holdings of gold and silver). Theory says you should have a trade surplus. Maximize exports through subsidies. Minimize imports through tariffs and quotas. David Hume (1752): persistent trade surplus will affect the money supply and in the long run close the trade surplus Key problem: “Zero-sum game”. 3 - 3 Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea Theories of International Trade: Absolute Advantage The exporting country holds a superiority in the .