Report: International Trade Theory Essay

Report: International Trade Theory

Chapter 5 “International Trade Theory” highlights key ideas and trade theory, comparative and absolute advantage, Heckscher-Ohlin theory, the product life cycle theory, new trade theory and national competitive advantage or, in other words, Porter’s diamond. The purpose of the chapter is to explain why every country should be engaged in international trade, what benefits it offers and what limitations or restrictions they may be faced with. Free trade is key element of democratic country. Generally, free trade is defined as any situation when country’s government doesn’t influence trade process through quotas or other restrictions. However, if domestic industry is not competitive enough, then it should avoid free trade as it would definitely hurt country’s industries. The key benefit of international trade is that any country is allowed to export products that are effectively produced in domestic industry, and to import products that are effectively produced in another country.

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Absolute advantage suggests that each party is able to find an effective productive niche based on absolute advantage meaning that each party is efficient at producing goods and at trading them with other states. The concept of comparative advantage is used to explain why it is beneficial for two countries to ensure trading without barriers if one party appears to be more efficient at producing either goods or services which are needed by another party. Heckscher-Ohlin theory suggests that differences in national factor endowments result in comparative advantage. Further, the life product cycle theory states that flow and trade are affected by products maturation meaning that the location of sales and location of optimal products change from time to time.  Finally, new trade theory suggests that profitability of any firm depends on increasing returns to specialization and economies of scale. Thus, there may be only a few profitable firms in some industries. Firms with advantages may develop economies of scale and establish barriers for other firms.