Orange and Brown Geometric Finance Company Presentation

[Audio] Theories of Trade Presentation. THEORIES.

[Audio] Theories of Trade can be broadly classified into two main categories: Absolute Advantage and Comparative Advantage..

[Audio] Countries should focus on producing goods and services where they have a natural ability to do so better than others. This idea was first proposed by Adam Smith in his book The Wealth of Nations, published in 1776. According to this theory, countries should specialize in producing those goods and services where they have a relative advantage over other nations..

[Audio] Country A has an absolute advantage over country B in producing good X when we assume constant opportunity cost, also known as linear production possibility frontier. Even if country B uses all its available resources, it cannot produce as much good X as country A. With the same level of resources, technology, and time, country A can produce more units of good X than country B. This absolute advantage gives country A a competitive edge in producing good X..

[Audio] Canada should produce only fish and Japan should produce only chips. The resulting trade pattern would be that Canada exports fish to Japan and Japan exports chips to Canada..

[Audio] Saudi Arabia has an absolute advantage in oil production because of its abundant reserves and low production costs. It can produce more oil than any other country, given the same level of resources, technology, and time. Similarly, Japan has an absolute advantage in electronics manufacturing due to its advanced technology and skilled workforce. China, on the other hand, has an absolute advantage in textile production due to its large workforce and low labor costs..

[Audio] The theories of trade, including absolute and comparative advantage, have some limitations and criticisms. They assume unrealistic scenarios, ignoring the fact that countries may not have unlimited resources or factor inputs. This assumption can lead to inaccurate predictions about international trade. Moreover, these theories do not consider opportunity costs, which are the benefits that could have been gained by choosing an alternative course of action. Additionally, they ignore trade barriers, such as tariffs and quotas, which can significantly affect international trade. Furthermore, they neglect the concept of multilateral trade, where multiple countries engage in trade with each other. These limitations highlight the need for more comprehensive and realistic models of international trade..

[Audio] Comparative advantage refers to the concept where a country, individual, or business produces a good or service at a lower opportunity cost compared to others. This idea was first introduced by David Ricardo in his book 'Principles of Political Economy and Taxation' published in 1817..

[Audio] Both countries have equal-sized economies where full employment exists. The opportunity costs of producing one good over another remain constant. Factors of production can move freely within each country but not across borders. Transport costs are negligible. Initially, both countries use half of their available resources to produce each good, under perfect competition..

[Audio] Canada's ability to produce both fish and chips surpasses that of another country. From an absolute perspective, Canada has an absolute advantage in both goods. As a result, it would not engage in international trade because it could meet its own demand without relying on imports. However, if we consider the concept of comparative advantage, we find that even though Canada excels in producing both goods, it may still have a lower opportunity cost when producing one of them compared to another country. This opens up the possibility of trade, as Canada could specialize in the production of that particular good and import the other..

[Audio] Suppose we have two countries, Canada and Japan, each with its own level of resources. Canada has a total level of resources of L, while Japan has a total level of resources of L*. This is our starting point for understanding international trade..

[Audio] Canada has a comparative advantage in producing fish because it can do so at a lower opportunity cost compared to Japan. This means that Canada's resources are being used more efficiently in producing fish, and it would be better off specializing in this industry. On the other hand, Japan has a comparative advantage in producing chips because its opportunity cost is lower compared to Canada. This suggests that Japan's resources are being used more efficiently in producing chips, and it would be better off specializing in this industry..

[Audio] If the comparative cost of production for Chips in Canada is higher than the fish production, it is evident that Canada would gain from shifting its production from Chips to Fish. Since the opportunity cost of producing Fish in Canada is lower than that of producing Chips, Canada can export Fish to Japan, which has an equal comparative cost of production for both Chips and Fish. Conversely, Japan can capitalize on its lower opportunity cost of producing Chips by exporting them to Canada. Consequently, both nations can profit from trade, as they focus on manufacturing goods in which they possess a comparative advantage..

[Audio] China's dominance in manufacturing electronics and Germany's strength in automobile production illustrate how countries can specialize in producing goods where they have a comparative advantage. China's low labor costs provide it with an edge in producing electronics, whereas Germany's advanced engineering and quality control enable it to produce high-quality cars. This specialization enables each country to reap benefits from trade, as they concentrate on producing goods where they possess a relative advantage over other nations..

[Audio] The limitations and criticisms of the theory of comparative advantage include that it is often difficult to determine in which goods countries have a comparative cost advantage due to the numerous goods and countries involved. Moreover, the theory neglects the impact of transportation costs, which could potentially eliminate any comparative advantage. Furthermore, modern theories have moved away from Ricardo's labor theory and instead require only that price ratios differ between countries for gains from trade to be possible..

[Audio] Ricardo's theory of comparative advantage ignores the role of demand completely, focusing solely on the supply side of the market. This limitation can lead to unrealistic conclusions about the benefits of trade. Additionally, his analysis relies heavily on the labour theory of value, which has been largely discredited by modern economists. Furthermore, the theory is only applicable to bilateral trade between two countries and two commodities, making it difficult to generalize to more complex trading scenarios. These limitations highlight the need for further refinement and expansion of the theory to better capture the complexities of international trade..

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