CHAPTER OUTLINES: Introduction. Classical Theories of Trade—absolute advantage, comparative advantage, the empirical evidence. The Terms of Trade. The Factor Proportions, Heckscher-Ohlin Theory of Trade—the Leontieff Paradox, other empirical evidence. Increasing Opportunity Costs. Indifference Curves. General Equilibrium. The Factor Price Equalisation Theorem. Demand-Side Theories of Trade. Economies of Scale. Technology-Based Theories of Trade—technology-gap trade, the product life-cycle model of trade. The Case of Monopoly. Conclusion.
Why do countries engage in trade? What benefits does trade bring to countries? What products will a country export and what will it import? What determines the pattern of its trade? And, since trade is the result of specialisation, what determines the products in which a country specialises? Moreover, how does a country’s pattern of specialisation and trade change over time? These are some of the questions which have pre-occupied trade theorists for over two centuries. In this chapter, we shall identify some of the theories which economists have developed (and the various theoretical tools which they have used in the process) in an attempt to answer these questions.
This chapter is primarily concerned with the basic or more conventional theories which set out the gains which countries can expect from specialising in those activities in which they are relatively efficient. These constitute necessary ‘building blocks’ for understanding the more esoteric models which have been developed in recent years, which take into account some of the complexities of trade in today’s world. These newer trade theories are not considered until Chapter 3. Usually, the term ‘conventional’ is restricted to the theory of trade expounded by the Classical and Neo-Classical schools of economic thought. However, this chapter also discusses some of the attempts of post-war economists to explain patterns of international trade and specialisation in a world where consumer preferences cannot be assumed to be identical and where technological innovation plays an important role.
Essentially, the basic theory of trade is concerned with answering two questions. The first seeks to explain how and why countries