Classical Theories Of Trade

The essay will be containing the information regarding economical issues and their impact on business trade. Management of all businesses needs some information to make important and smart decisions followed by the theories and patterns, which have the direct impact on the business operations (Andrew, 2003). These decisions can lead a business to grow at its peak or can cause a failure which can be the end of the business (Robert, 2010). The essay will be focusing on the impact of classical theories on modern trade theories.

Classical theories of trade are the basic trade patterns which were followed by the people in early ages (Lucas, 1988). In this report all the classical theories will be covered with examples. Modern trade theories are made from those classical theories, as classical theories are the pillars of modern trade theories (Kowalski, 2011). For a successful Trade strategy, an organization needs to learn the pattern, experiences which was followed by the firms in the past (Mundell, 1957). Formation of effective, sound and well defined trade policy can bring a long-term success in the economy but even a perfect strategy won’t help the economy to grow unless and until it doesn’t implement (Yi, 2003). The information should be proper and based on facts, and figures should be used while formulating a trade strategy (Andrew, 2003).

All factors plays an important role while making a strategic alignment but the paper will be more focusing on the economical aspects of the modern trade theory and impact of classical theories on it (Appleyard et al, (2010).

International Trade:

International trade theory explains the pattern for international trading between the countries around the globe (Robert & Constantine, 1997). The theory for international trade tells the benefits of exchange of commodities, technology, human resource and every exchangeable item or skill for return. International trade between the countries is growing rapidly as world trade is the most outstanding factor for the economic growth of a country (Robert, 2010). The basic reason for world trade is to give more benefits to the nations, in term of price of the commodity, technology advancement, in short to provide a better living standard to the nation (Tinbergen, 1962).

The basic definition of international trade is the exchange of items or commodities between countries to country without considering the nation boundary (Mundell, 1957). The concept of global village has made a remarkable growth in international trade (Robert & Constantine, 1997). The concept of one village means all the nations around the world have equal rights, equal living standards (Lucas, 1988). The basic factors which influence the economist, policy makers and traders for international trade is political, economic, social, technological and cultural factors (Summers, et al. 1991).

In international trade a country opens its economy from close economy to open economy (Pugel, 2012). Close economy means the country neither import nor export any commodity or resource (Romalis, 2004). In open economy, the exchange of good, items and resource are allowed by the law of the country (Pugel, 2012). International trade not only increase the chances of business but also benefits the globe (Lancaster, 1980). The trade is beneficial for countries to do mass production and reduce the cost (Helpman, 1987). Technology advancement, labour sharing and helping third world countries are also the advantages of international trade (Yi, 2003). International trade is very common around the globe but it has stages or levels or growth (Summers, et al. 1991). Classical and modern concepts of international trade will be discussed below in the essay.

The benefits of international trade are to share the technology advancement among the countries as well as resources (Tinbergen, 1962). For example, if a country`s land is not good enough to fertilize crops, it will import from another country to fulfil the need of it. The both countries will get benefits from it, the importer country will get the corps and the exporter country will get the money which will make its economy more strong. The exporter country can utilize the money in research and development to increase the per acre growth of corps.

CLASSICAL THEORIES

In classical theory of international trade, a country is changing its economy to open economy which means trade is allowed by the government (Romalis, 2004). Mostly the reason for which governments have banned the trade was to enforce people for setting up more business and produce everything within the country but the concept of global village and economical conditions force all the countries to go for free trade (Robert & Constantine, 1997). Closed economy increases the cost of production without any changes in the sales of the commodity (Appleyard et al, (2010). For example, a company have produced a TV in the closed economy. It has targeted the people smartly and captured the whole market of TV, but at that level there will be no increase in the sales unless and until the population of the country increase. But at the same time, the production cost will be increasing due to main two reasons; 1st every one in the country have already purchased the TV so the people whose TV is not in working condition are buying it. Seconds the less production has increased the cost as the fixed cost is high. At the end the government force to change the economy from close to free trade.

Moving from close economy to free trade economy give the benefits to the countries in term of economic gains and resource allocations (Mundell, 1957). It helps the production units to adopt new technologies, skills which lead them to high production (Helpman, 1987). India is the example of closed economy which recently changed its trade policy to free trade economy.

Mercantilism

It is the evolution of trade which turns the local economies to national economies and local trade to international trade (Tinbergen, 1962). It is the system followed by the major developed countries during the 16th century. In mercantilism the developed countries were exporting the commodities and resources to under develop countries and they believe was not to import anything from other countries (Lucas, 1988). The importing countries have to pay the import material amount in shape of metals, like gold (Lancaster, 1980).

The theory was focused on the concept that the wealth of the world in limited (Tinbergen, 1962). If a country wants to increase its wealth, it has to take from another country in shape of import/export (Yi, 2003). But the concept was more export than import to increase the wealth of the country as the return of the export will be in metal shape which will increase the country`s wealth (Romalis, 2004).

This theory was criticized as it weakened the living standard of the people (Lancaster, 1980). This concept have increased the production cost and results in inflation (Pugel, 2012).

The Absolute Advantage

Mercantilism policies were creating hurdles for economic progress of countries (Pugel, 2012). In mercantilism few countries were growing and collecting the wealth of the world (Mundell, 1957). To overcome mercantilism trade theory, Adam smith the father of economics gave a new concept for trade in which he advices the countries to only export those products which are produce in excess quantity and the country is expert in that products technology and resources (Kowalski, 2011). Adam smith says that the country should follow the same strategy for import (Pugel, 2012).

Adam Smith’s theory gave the idea that the import of those products which the country is not effective and efficient in production should import (Pugel, 2012). In order to reduce the cost and the quality of the commodity this can better satisfy the nations need instead of producing it in the internal market (Kowalski, 2011).

Adam smith changes the concept of the cost determination in term of labours spends on a unit of production (Robert, 2010). Resources are limited in the world, if a country wants to exceed the productions of a commodity it has to limit the production of other commodity (Pugel, 2012).

Example: if A country is producing 10 units of cloths by an amount of input by which the B country is producing 8 units of cloths. Country A should emphasise more on cloths production as it is effective and efficient in it.

The Comparative Advantage:

In this concept of trade the country should focus on the production of commodities in which it is more productive, efficient and effective than any other country of the world (Kowalski, 2011). The country should focus on the production of those exchangeable goods or commodities in which it produces more units by a given amount of input (Helpman, 1987).

In comparative advantage the country has an edge over its trading partner, and has more chances to capture the trading market over its competitor country. The comparative advantage can be for labour, land and capital (Mundell, 1957). In comparative advantage opportunity cost is the basic factor which determines the edge over competitor (Lancaster, 1980). The country will export those products in which it has a comparative advantage but at the same time it will import those product in which is it least effective and efficient from those countries that have comparative or opportunity cost advantage (Kowalski, 2011).

comparative_advantage_graph.gif (Econport, 2006)

Modern Trade Patterns:

The modern trade theory revolves around three factors which are competitive structure, technology and scale of production (Robert, 2010). According to Ohlin theory of trade, countries trade because of the difference between the resources of two countries (Pugel, 2012). Competitive structure includes the competitive edge over the competitors and the situation of competitors including the analysis of competitors (Kowalski, 2011). Technology and economies of scale are the drivers of economy (Mundell, 1957). Technology is one of the most important factors which determine the cost and efficiency of the unit produced. Day by day technological changes have been made in the production process and advancement in the formulas of the production as well. Technology is the factor which can either make the unit cost so high or the unit cost can be a minimum (Appleyard et al, (2010).

Economies of scale mean production in large quantity. If a country produces a certain product in large quantity it can lower the cost as the cost of the product is divided into two parts, variable and fixed cost (Lancaster, 1980). If the production is done in limited quantity the cost will be high as the fixed cost will be same for any number of units produced. But in case the large quantity is produced the fixed cost will be divided onto all units produced which can lower the cost of the unit (Appleyard et al, (2010).

pug75756_0601

Conclusion:

The theory for international trade tells the benefits of exchange of commodities, technology, human resource and every exchangeable item or skill for return. International trade between the countries is growing rapidly as world trade is the most outstanding factor for the economic growth of a country (Robert, 2010). The classical theory of trade focused more on the conditions of trade rather than the factors on which the trading depends or the factors which drives the economy. In modern trade pattern the world is recognise as one village. The concept of one village means all the nations around the world have equal rights, equal living standards (Lucas, 1988). The basic factors which influence the economist, policy makers and traders for international trade is political, economic, social, technological and cultural factors (Summers, et al. 1991). The modern trade theory revolves around three factors which are competitive structure, technology and scale of production (Robert, 2010).