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Unit 2: Theories of International Trade
Hitesh Jhanji, Lovely Professional University

unit 2: theories of international trade notes

contents
Objectives

Introduction
2.1 Theories of International Trade – Mercantilism
2.2 Theory of Absolute Cost Advantage
2.3 Comparative Cost Advantage Theory
2.4 Relative Factor Endowment Theory
2.4.1 Explanation of the Theory
2.4.2 Concept of Relative Factor Endowment
2.5 Country Similarity Theory
2.6 Product Life Cycle Theory
2.6.1 Stages of Product Life Cycle
2.6.2 Trade Implications of the Product Cycle Theory
2.6.3 Limitations of Product Life Cycle Theory
2.7 Summary

2.8 Keywords
2.9 Review Questions
2.10 Further Readings

objectives

After studying this unit, you should be able to:
l z Examine theories that explain why they are beneficial for a country to engage in international
trade

l z Describe the comparative advantage theory
l z Explain the product life cycle theory
l z Discuss the relative factor endowment theory

introduction

The fundamental question that arises at this juncture is why should the business firms of one
country go to another country, when the industries of that country also produce goods and market
them? What is the basis for international business? A number of theories have been developed to
explain the basis of international business.

2.1 theories of international trade – mercantilism

Mercantilists maintained that the way a nation became rich and powerful was to export more
than it imported. The resulting export surplus would then be settled by an inflow of bullion or
precious metals, primarily gold and silver. Thus, the Government had to do all in its power to
stimulate the nation’s exports and discourage and restrict imports (particularly the import of
luxury consumption of goods).

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