Chapter Two

International Trade Theories

Outlines
 Historical Development of Modern Trade Theory
 Mercantilists’ View on Trade
 Physiocracy: A Link between Mercantilism and Classical
School
 The Classical/Traditional Trade Theories
 The Neoclassical Trade Theories
 The New/Modern Trade Theories
 The Point of Departure from the Traditional/Classical
trade Theories
 The Emergence and Development of the New Trade
Theories
1
 International Trade Theories
International trade theories propose different aspects of
trading practices such as:
 Reasons for trade, gains from trade and terms of trade
(exchange ratio between products)
 Helps to predict the size, content and direction of trade
flows
Based on different arguments, Economists brought
different models of trade pattern at three phases.
Pre-classical=>Mercantilists
Classical and Neoclassical=>A. Smith, D. Ricardo
and J. S. Mill
Modern schools =>E. Heckscher and B. Ohlin 2
 Historical Development of Modern Trade Theory
1. Pre- Classical theory of International Trade
(Mercantilism views)
During the period 1500–1800, a group of writers appeared in
Europe who were concerned with the process of nation
building.
According to the mercantilists, the central question was how
a nation could regulate its domestic and international affairs
so as to promote its own interests. The solution lay in a strong
foreign-trade sector.
If a country could achieve a favorable trade balance (a
surplus of exports over imports), it would realize net
payments received from the rest of the world in the form of
gold and silver.
Such revenues would contribute to increased spending and a rise
3
in domestic output and employment.
 Cont….
To promote a favorable trade balance, the mercantilists
advocated government regulation of trade.
Tariffs, quotas, and other commercial policies were proposed
by the mercantilists to minimize imports in order to protect a
nation’s trade position.
Economic philosophy of 𝟏𝟕𝒕𝒉 c and 𝟏𝟖𝒕𝒉 c with its doctrine
“country could grow rich and prosperous by acquiring
more and more precious metals i.e. gold and silver.
Efforts of the state should be directed towards the
accumulation of precious metals through export promotion.
Import supposed to be bad=>Gold is exchanged for
commodities w/c may results in the depletion of resource.
4
 Cont….

Nation to lose gold or silver, if it imported a greater value of

goods and services than it sold to foreigners => favors trade
surplus

In any event, mercantilists advocated strict government

control of all economic activity and preached economic
nationalism; because they believed that a nation could gain
in trade only at the expense of other nations => zero sum
game in trade

5
 2. Physiocracy: A Link between Mercantilism and
Classical School
Adam Smith led an eloquent/fluent and vigorous/vital attack
upon mercantilist theories of international trade in his book
“Wealth of Nations” published in 1776.
[Link] argued that it was absurd/illogical to manufacture a
commodity in a country at a great expense if a similar commodity
could be supplied from foreign countries at a lower cost.
[Link], thus, opposed the imposition of tariffs on the goods
imported from other countries, and recommended that trade
among different countries should be free and be based on
'territorial division of labor‟.
He advocated, the doctrines of laissez-faire, or free markets,
interpreted as economic welfare in a far wider sense of
encompassing the entire population. 6
 Cont….
Cont.
3. The mercantilists were also attacked for their static view
of the world economy.
To the mercantilists, the world‟s wealth was fixed. This
meant that one nation’s gains from trade came at the expense
of its trading partners; not all nations could simultaneously
enjoy the benefits of international trade.
According to Smith (1723–1790), the world‟s wealth is not a
fixed quantity.
International trade permits nations to take advantage of
specialization and the division of labor, which increase the
general level of productivity within a country and thus
increase world output (wealth).

7
 Cont….
Smith‟s dynamic view of trade suggested that both trading
partners could simultaneously enjoy higher levels of
production and consumption with trade.

4. According to David Hume‟s price-specie-flow doctrine, a

favorable trade balance was possible only in the short run, for
over time it would automatically be eliminated.
Inflow would increase the amount of money in
circulation. This would lead to a rise price level relative to that of
its trading partners.
Residents would therefore be encouraged to purchase foreign-produced
goods, while exports would decline. As a result, the country’s trade
8
surplus would eventually be eliminated.
[Link] Classical /Traditional Trade Theories

Three classical theories

A. Absolute advantage model

B. Comparative advantage model

C. Reciprocal demand model

9
 A. Absolute Advantage: Adam Smith (1723 –
1790)

Adam Smith, Scottish philosopher and economist: "The

Wealth of Nations", on free trade and market economics
(1776) "Little else is required to carry a state to the highest
degree of opulence/richness from the lowest barbarism but
peace, easy taxes, and a tolerable administration of justice.“
ADAM SMITH, 1755

10
 Theories of Absolute Advantage
 He provided the basic building block for the construction
of via his contribution on Absolute cost Advantage.
 A country has an absolute advantage in the production of
a good if it can produce more of the good with a fixed
amount of resources than any other country (i.e. when the
country uses fewer resources to produce a product than the
other country).
 He challenged the mercantilists views, “saying that goods
rather than gold were the true measure of the wealth of a
nation.
11
 Cont….
• He also shattered/crashed the mercantilist myth that
in international trade, one country gains at the cost of
other countries, showing all nations gains from trade at
least through division of labor.

• Adam smith viewed that for two nations to trade with

each other voluntarily, both nations must gain.

• If one nation gained nothing or lost, it would simply

refuse to trade.
12
 Cont….
According to Adam Smith, trade between two nations is based on
absolute advantage.

When one nation is more efficient than (or has an absolute

advantage over) over another in the production of one
commodity but is less efficient than (or has an absolute
disadvantage with respect to) the other nation in producing a
second commodity, then both nations through trade can gain
by each specializing in the production of the commodity of its
absolute advantage and exchanging part of its output with the
13
other nation for the commodity of its absolute disadvantage.
 Cont….
• Export those goods and services for which a country is
more productive than other countries.

• Import those goods and services for which other countries

are more productive than it is.

14
 Absolute Advantage Assumptions
i. Labor is the only factor of production and is homogenous
Labor was completely free to move within a single country, yet
it was entirely immobile internationally.
If labor were free to move between nations, then differences in
wage rates and hence commodity prices could be equalized via
labor migration, and there would be no need for international
trade
ii. Both countries can produce two commodities
iii. No transportation costs were involved in trade
iv. There existed no other barriers, such as tariffs and quotas,
to trade between countries.
v. Constant returns to scale.
vi. It is 2*2 model (i.e 2 country and 2 commodities)
15
 Illustration of absolute advantage
Imagine, two countries, country A and country B. Both
countries produce significant quantities of wheat and oil for
domestic consumption, and there are absolutely no trade
relations, factor movements, or other economic ties between
them; i.e., each is taken to be operating in a state of isolation
(autarky).
• Assume for the moment also that the entire value of the two
commodities is the amount of labor used in their production.
• Now suppose, further, that one man-hour of labor can
produce the following quantities of wheat and oil in the two
respective countries:
16
Theories of Absolute Advantage
Autarky situation both countries:

17
 Interpretation
According to Smith, if one country has an absolute advantage
over another in one line of production, and the other country has
an absolute advantage over the first country in another line of
production, then both countries would gain by trading.

Hence from the above table: country A has an absolute

advantage in the production of oil (10 barrel is greater than
5 barrel), while

Country B has an absolute advantage in the production

of wheat (10 quintal is greater than 5 quintal).
18
 Benefits from trade:
To see the benefit from an international trade, it is better to begin
from autarky that shows the combination of both goods produced
and consumed by each country before trade.

Table 2: Pre trade production and consumption

When both countries produce wheat and oil for domestic

consumption, and absolutely no trade relations exist between
two countries, the world production would be 15 quintals of
wheat and 15 barrels of oil.
19
 Opened economy
If the two countries opened their economy, the direction that trade
would take can be immediately determined. Therefore, country A
would export oil to country B, in return for which country B
would export wheat to country A. In this case there is a scope for
complete specialization in production in both countries. The
effect of opening trade between the two countries is shown in the
following table. The table below reveals that before trade both
countries produce only 15 units each of the two commodities by
applying one labor-unit on each commodity.
 If A were to specialize in producing in oil production and use
both units of labor on it, its total production will be 20 units of oil.
Similarly, if B were to specialize in the production of wheat alone,
its total production will be 20 units of wheat.
The combined gain to both countries from trade will be 5 units of
oil and 5 unit of wheat for country A and B, respectively. 20
 Cont….

As a result of trade, the total production of the two countries

went up.
This means that both countries become richer or have become
better off in terms of production, after trade as compared to
21
before trade, without making any country worse off.
 Criticism on theory of absolute advantage‟s Flaw (Error)
What happens to trade if one country has an absolute advantage
in both products? No trade would occur
Smith has been criticized for his vagueness and lack of clarity.
Accordingly, Smith assumes without argument that international
trade requires an exporting country to have superiority with a
given amount of capital and labor to produce a larger output than
any rival. But this basis of trade is not realistic because there
are many underdeveloped countries which do not possess
absolute advantage in the production of any commodity, and
yet they have trade relations with other countries.

Thus, Smith's analysis is weak and unrealistic.

22
B. Comparative Advantage: D. Ricardo (1722 – 1823)
 Ricardo‘s modal is a further refinement/modify of Smiths„
model
 The most basic concept in the whole of international
trade theory.
 Comparative advantage is the ability of a firm or
individual to produce goods and/or services at a lower
opportunity cost than other firms or individuals.
 It gives a company the ability to sell goods and services at a
lower price than its competitors and realize stronger sales
margins.
Causes of Comparative advantage:
• Technological/labor productivity differences
• Resource endowment difference
• Gains from economies of scale 23
 Assumptions of the Comparative advantage Model
A1: Two countries, two goods(homogenous), one factor(L):
2x2x1 model

A2: Only one factor of production: Labor (L)

• Fully employed
• Fixed supply
• Its productivity is constant in each country and industry
but differs between industries and countries

A3: Labor Mobility

• Labor is cost less mobile across industries, but Immobile
across countries 24
 Cont….
Cont.
A4: Production takes place under perfect condition

A5: Consumption takes place under utility maximization

Consumers in each country maximize utility subject to
budget constraint
Preferences are homothetic
A6: Zero transportation costs

A7: Constant returns to scale in production of both goods

in the two countries (constant marginal opportunity cost
condition)

25
 Cont….
According to comparative advantage theory, international
trade between countries should depends on comparative cost
differences (comparative advantage).
A country is said to have comparative advantage in
producing a good if the opportunity cost of producing that
good in terms of the other good is lower in that country than
it is in other country.
Thus, comparative advantage=lower opportunity cost
advantage
The opportunity cost of producing one unit of X in terms of Y is:
𝑶𝒑𝒑𝑿,𝒀 = 𝒀/𝑿 in terms of output
𝑶𝒑𝒑𝑿,𝒀 = 𝒄𝒐𝒔𝒕 𝒐𝒇 𝑿/𝒄𝒐𝒔𝒕 𝒐𝒇 𝒀 in terms of relative cost
26
 Cont….
Example: Assume that there are two countries: Ethio & Kenya
• Both produce two goods ( Rose & Computer)
• Both have labor factor
The following table shows unit labor requirement to produce 1
unit of rose & computer.

The opp. Cost of one unit of rose in Ethiopia is= 1/3=0.33.

The opp. cost of one unit of rose in Kenya is = 3/4 = 0.75
The opp. Cost of one unit of computer in Ethiopia is= 3/1= 3
The opp. cost of one unit of computer in Kenya is = 4/3= 1.33
27
 Cont….
Thus, Ethiopia has comparative advantage in the production
of rose (and disadvantage in the production of computer)
since its opportunity cost is low relative to in Kenya (0.33 vs
0.75)

Kenya has comparative advantage in the production of

computer (but, has comparative disadvantage in the rose
production) since its opportunity cost is low relative to in
Ethiopia ( 1.33 vs 3).

Absolute advantage=lower absolute cost advantage (unit

cost advantage). 28
 Limitations of the Comparative Advantage Model
1. Because of one factor economy assumption, it predicts
that countries as a whole will always gain from
international trade. Thus, it assumes away the effects of
trade on distributions of income within countries.

2. Allows no role for differences in resources among

countries as a cause of trade.

3. Because of a constant cost industry assumption, neglects

a possible role of economies of scale/increasing returns to
scale as a cause of trade.
29
 C. Law of Reciprocal Demand Offer curve Analysis

• The Principle of Reciprocal Demand was developed by J.S. Mill

in 1848 when he wrote his book: Principles of Political Economy.

• Later offer curve technique was developed by Edgeworth and

Marshall.

• The offer curve tries to show how the terms of trade are
determined by the interaction of demand and supply. Their merit
lies in the fact that they resolve the problem of determining
the exact terms of trade that emerge in trade equilibrium.
Assumptions
• Simple model of the world with two countries A and B
• Country A specializes in the production of textile and B in
30
the
production of rubber.
 Cont….
The TOT, then according to the law of reciprocal
demand, are determined by A‟s demand for B‟s product
and B‟s demand for A‟s product.

 In other words, the TOT are determined by the intensity of

domestic demand for foreign goods (offer curve of the
country A) and of the foreign demand for domestic good
(offer curve of the other country B).

The equilibrium TOT is determined at the point where the

offer curves of the two countries intersect. 31
 Cont….
Table 14: Schedule of Trade Propensity for country A
Textile Rubber Potential
(Exportable) (Importable) Terms of Trade ratios
25 5 5:1
40 10 4:1
60 20 3:1
80 40 2:1
100 100 1:1
90 120 0.75:1

 The above table indicates that textile is country A’s exportable

product, and rubber is its importable product.
 Country A has completely specialized in the production of textile,
because it has an absolute or comparative advantage in this line of
production.
 If consumers in country A want to consume rubber, it can be fulfilled
only by importing it from country B, which has achieved complete
32
specialization in rubber production.
 Cont….
• Initially when country A does not have any rubber to
consume at all, it is willing to export 25 units of textile in
exchange for 5 units of rubber implying trade takes place at
5:1 terms of trade.

33
 3. The Neo Classical Trade Theory
 The Neoclassical Theory of International Trade is a
framework that builds on classical economics but
incorporates more sophisticated mathematical models
and assumptions about how international trade operates.
 The neoclassical model of international trade has been
developed using the concepts of opportunity costs, production
possibilities curve and community indifference curves.
 It emphasizes efficiency, specialization, and the benefits
that arise when countries focus on their comparative
advantage. 34
 Assumptions of the Neoclassical Trade Model
 Perfect competition: The model assumes that all markets (for
goods and factors) are perfectly competitive, meaning that no
single firm or country can influence market prices.
 Factor mobility within countries: Factors of production (labor,
capital) can move freely between industries within a country,
but are immobile between countries.
 Identical technologies: All countries have access to the same
technology, so technological differences do not explain trade
patterns.
 Two countries, two goods: The simplest neoclassical models
often analyze trade between two countries and two goods. 35
 Cont….
No transport costs: The model assumes that there are no
costs involved in moving goods between countries, which is
often not the case in the real world.

No trade barriers: The model assumes that trade is not

hindered by tariffs, quotas, or other barriers

11/7/2025 36
 Implications of the Neoclassical Theory
Gains from Trade: The core message of the neoclassical
theory is that both countries gain from trade when they
specialize based on their comparative advantages.
Economic Growth: The theory suggests that trade
encourages specialization, which can drive economic growth
by increasing productivity and improving access to goods
and services.
Global Efficiency: By focusing on producing the goods in
which they have the lowest opportunity cost, countries can
achieve a more efficient global economy.
Income Distribution Effects: Although trade is beneficial at
the national level, there can be significant redistribution of
income within countries.
11/7/2025 37
 Criticisms of the Neoclassical Theory of International trade
Unrealistic Assumptions: The assumptions of the neoclassical
model (perfect competition, identical technologies, no transport
costs) do not reflect real-world conditions.
Factor Price Equalization: In practice, trade does not always
lead to the equalization of factor prices.
Differences in wages, returns to capital, and other factor prices
persist across countries due to market imperfections and
government policies.
Imperfect Mobility of Factors: In reality, factors of
production (labor and capital) are not always as mobile
within countries as assumed.
Trade Barriers: Real-world trade is often influenced by
tariffs, quotas, and non-tariff barriers, which can
significantly distort trade flows and outcomes.
11/7/2025 38
 4. The Modern Theory of International Trade
In the previous sub unit we discussed the theory of
comparative advantage in terms of a one factor model,
where the only factor was labor, and comparative
advantage was determined by technological differences.

We saw that the move to free trade leads to a transfer of labor
from the import competing sector to the export sector.

 So far we have seen that the difference in relative

commodity prices between two nations (or the terms of trade)
is evidence of their comparative advantage and forms the
basis for mutually beneficial trade. 39
 Cont….
In the classical economists approach comparative
advantage was based on the difference in the productivity
of labor (the only factor of production they explicitly
considered) among nations, but they provided no
explanation for such a difference in productivity.

The Heckscher-Ohlin theory goes much beyond that by

extending the trade model discussed in the previous sub units
to examine the basis for comparative advantage and trade's
impact on factor earnings.
11/7/2025 40
 I. The Hecksher Ohlin (H-O) theory
The H-O theory is a theory of long term general
equilibrium in which the two factors are both mobile
between sectors and the cause of trade is different
countries having different relative factors endowment.

The H-O theory is based on a number of simplifying

assumptions.

Note, however, that to make the theory more realistic we

will relax these assumptions latter on.

The assumptions are:

11/7/2025 41
 Cont….
i) There are two nations (nation 1 and nation 2), two commodities
(commodity x and commodity y), and two factors of production
(labor and capital)
ii) Both nations use the same technology in production
iii) Commodity x is labor intensive and commodity y is capital
intensive in both nations
iv) Both commodities are produced under constant returns to scale
in both nations
v) There is incomplete specialization in production in both nations
vi) There is perfect competition in both commodities and factor
markets in both nations

vii) There is perfect factor mobility within each nation but no

international
11/7/2025 factor mobility 42
 Cont….
viii) There are no transportation cost, tariffs or other
obstructions to the free flow of international trade

ix) All resources are fully employed in both nations

Assumption IV(constant returns to scale in both nations)
implies that increasing the amount of labor and capital used
in the production of any commodity will increase output of
that commodity in the same proportion.
In order to have full understanding of the H-O theory we
need to define some basic concepts
11/7/2025 43
 The Concept of Factor Intensity and Factor Abundance
Since the H-O theory is expressed in terms of factor intensity and
factor abundance, it is crucial that the meaning of these terms be
very clear and precise.
I. Factor Intensity
In a world of two commodities (x and y) and two factors (labor
and capital), we say that commodity y is capital intensive if the
capital-labor ratio (K/L) used in the production of y is greater
than K/L used in the production of x.
For example if two units of capital (2k) and two units of labor
(2L) are required to produce one unit of commodity, the capital-
labor ratio is one.
 If at the same time 1K and 4L are required to produce one unit of
x, K/L = ¼, for commodity x. Thus we say y is k intensive and x
is L11/7/2025
intensive 44
 Cont….
Note that it is not the absolute amount of capital and labor used in
production of commodities x and y that is important in measuring the
capital and labor intensity of two commodities but the amount of
capital per unit of labor (i.e., K/L).

 Note, however, that countries use more capital or labor intensive

production techniques if the resource used intensively is cheaper one.
II. Factor Abundance
There are two ways to define factor abundance. One way is in terms
of physical units.

 That is in terms of the overall amount of capital and labor available

in each nation.
11/7/2025 45
 Cont….
According to this, nation 2 is capital abundant if the ratio
of the total amount of capital to the total amount of labor
(TK/TL) available in nations 2 is greater than in nation 1.

Note that it is not the absolute amount of capital and labor

available in each nation that is important but the ratio of the
total amount of capital to the total amount of labor.

Thus, nation 2 can have less capital than nation 1 but still be
the capital abundant nation if TK/TL in nation 2 exceeds
TK/TL in nation 1.
11/7/2025 46
 Cont….
Another way to define factor abundance is in terms of
relative factor prices.

According to this definition nation 2 is capital abundant if

the ratio of the rental price of capital to the price of labor
(Pk/PL) is lower in nation 2 than in nation 1.

Note that the rental price of capital is usually taken to be

the interest rate (r) while the price of labor time is the
wage rate (w) (i.e. PK/PL = r/w).

11/7/2025 47
 II. Factor Price Equalization (FPE)
This theorem is a corollary of the H-O theorem. It holds
only if the H-O theorem holds.
This was proved by Paul Samuelsson and for this reason; it
is sometimes referred to as the H-O-S theorem.
The theorem states that free trade between countries in a
H-O world will equalize relative factor prices provided
that neither country specialized completely.
 In other words it states that international trade will bring
about equalization in the relative and absolute returns to
homogenous factors across nations.
Note that we can only obtain absolute factor price
equalization if we have the relative factor price
equalization.
48
 [Link] New Trade Theories
Several economists have discussed some new approaches
to trade theories which are explained as follows

I. Linder's Theory of volume of Trade and Demand

Pattern

A Swedish economist S.B. Linder has propounded (in

1961) a theory that explains the volume of trade in
manufactures as a proportion of national income between
different pairs of trading countries.
11/7/2025 49
 Cont….
This theory is also known as preference similarity
hypothesis.
Linder argues that as a country's per capita income grows, its
representative demand pattern causes an expansion in the
domestic production of certain manufactures.
Linder's theory is based on the following assumptions.
1. A country's potential trade is limited to those goods which
have a domestic demand.
2. The potential trade between two countries is limited to those
goods for which demand exists in both countries.
3. The goods for which domestic demand exists is determined
by per capita income.
4. The potential trade between two countries depends on
broadly
11/7/2025similar income levels. 50
 Cont….
The analytical framework of Linder's theory can be
explained as follows.
The pre condition for trade in manufacturers as an export is
the presence of home demand.
This is due to several reasons:
i) foreign trade is only an extension of domestic trade
ii) there are innovating centers on existing industries
iii) it is domestic demand which gives manufactures export
possibility.
Linder's theory is an improvement over the H-O theory.
11/7/2025 51
 Cont….
The latter is based on the hypothesis that it is differences in
factor endowments that lead to trade between two
countries.
On the other hand, Linder's theory asserts that trade can take
place when factor endowments are similar (i.e. similar
capital labor ratio and per capita income levels)

11/7/2025 52
 Cont….
Linder's theory has certain weaknesses. some of
which is stated hereunder.
The theory does not explain the reason that leads a
country to develop the home market for a product which
it ultimately exports.
The theory does not clarify the meaning of quality, how
it can be measured and why it alone varies with per
capita income and affect trade
The theory does not lay down the conditions that can be
expected to influence the volume of trade, the goods that
will be imported and exported, etc.
11/7/2025 53
 Cont….
In conclusion, despite these weaknesses Linder's approach
is novel and ingenious which explains the reasons for large
volume of trade in manufactures among developed countries.
It also highlights the fact that the lion's share of the world
trade is among the developed countries with broadly
similar per capita incomes rather than between the developed
and under developed countries.

11/7/2025 54
 II. Technological Gap or Imitation Gap Theory
Recall that the Ricardian and H-O theories are based on
the assumption that technology is the same in all trading
countries. As such, they do not analyze the effect of
technological change on trade.
This theory is developed by M.V Posner in 1961.
He analyzed the effect of technology on trade.
Posner regards technological changes as a continuous
process which influences the pattern of international trade.

He argued that a technological innovation in the form of

product of a new good in one country leads to the imitation
gap and the demand gap in the other country.
11/7/2025 55
 Cont….
The extent to which trade will take place between the two
countries depends on the net effect of the demand lag and
imitation gap.
Posner's theory is based on the following assumptions:
i)there are two countries with similar factor endowments
ii)demand conditions are similar
iii)pre trade factor price ratios are similar in both
countries while their technologies differ.
In view of the above assumptions, the imitation gap theory
explains the sequence of innovation and imitation as it
affects the pattern of trade.
When a firm innovates in the form of new product which
becomes profitable in the domestic market, it enjoys a
temporary
11/7/2025 monopoly. 56
 III. Product Cycle Theory
This theory is developed by R. Vernon (1966) and elaborated by
Hirsch (1967).
The hypothesis sates that the development of a new product
moves through a cycle or a series of stage in the course of its
development, and its comparative advantage changes as it
moves through the cycle.
The product cycle is a variant or strand of the technological gap
theory.
According to Vernon some countries are relatively rich in capital
and some relatively land abundant and some others relatively
labor abundant.
 He argued that many new products are more likely to be
developed initially in capital rich countries like United States
because of its comparative advantage in research and development
(R&D).
The new products that are likely to develop are consumer
products
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that seem to have a ready domestic market. 57
 Cont….
Vernon suggests the following three stages in the life
cycle of a product.
A. New product stage: In the first stage production requires
highly skilled labor in the production process. While the
product is being developed, costs are high.
Given the risk and uncertainty of the new investment, the
main consideration for the innovating producer is the
existence of a ready domestic market where demand is less
elastic for the new product.
B. Maturing product stage. In the second stage, there is mass
production and distribution of the new product costs and
prices fall, and the product is exported.
The innovating country continues to have a monopoly in
producing and exporting the product.
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 Cont….
Its monopoly depends upon:
a. the rate of growth in demand in foreign markets
b. the nature of product developed
c. the speed with which other countries acquire the new
technology
d. the effectiveness of patent rights
e. the extent of scale economies; and
f. the organization of industry.

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 Cont….
C. Standardized products stage: In this stage, the product and
manufacturing operations become standardized in the innovating
country.

• Sales fall, elasticity of demand is high and exports fall. This

becomes possible when after a lag, other advanced countries start
producing the new product, often with the help of subsidiaries set
up by producers of the innovating country.

• As the technology in this product line becomes common and

increasingly standardized, the innovating country loses its
comparative
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 IV. Intra-Industry Trade
Inter industry international trade refers to a situation
where the commodity of one industry is exchanged
for the commodity of a different industry.
o Fore example, Ethiopian coffee is traded for Germany
machinery. Inter-industry international trade is based
on the assumption of perfect competition.
On the other hand; in intra-industry international
trade is the trade within an industry in differentiated
products which are similar but not identical.
 For example German cars are traded for French cars,
and so are computers, soaps, shoes, books and
innumerable other products are traded between
nations.
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 Cont….
 Intra-industry trade is due to specialization and
increased division of labor which is dependent on the size
of the market with rapid economic growth and
globalization of the world economy, intra-industry trade
has spread in intermediate products and finished products.
 It has also spread as border trade due to high transport costs
and as seasonal trade due to high storage costs of fruits and
vegetables between countries.
 Intra-industry trade takes place because domestic and
foreign firms that make identical varieties of the same
product will invade each other's national market.

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