Free trade refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country, or what they can produce and sell to another country. The economic arguments surrounding the benefits and costs of free trade in goods and services are not abstract academic ones. International trade theory has shaped the economic policy of many nations for the past 50 years. The textbook reviews six main trade theories: Adam Smith's theory of absolute advantage; David Ricardo's theory of comparative advantage; the Heckscher-Ohlin theory and the product life-cycle theory, both of which extend various aspects of Ricardo's theory; the new trade theory explaining the benefits from trade without national differences in resource endowments or technology; and national competitive advantage theory drawing attention to an international success in a particular industry. All these theories identify the specific benefits of international trade, help to explain the patterns of international trade, and government trade policies.
Match the correct theory with its corresponding description and time period in the evolution of international trade theory.
1. Established in 1776, Adam Smith stated in this theory that countries should specialize in the production of goods and services for which they can produce most efficiently and then trade these for goods produced by other countries.
2. In 1817, David Ricardo stated that it makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries.
3. In the early 1900s, this theory predicts that countries will export those goods that make intensive use of factors that are locally abundant and import goods that make intensive use of factors that are locally scarce.
4. In the mid-1960s, a theory initially proposed by Raymond Vernon, points out that where a new product is introduced is important. Over time, cost considerations start playing a greater role in the competitive process.
5. Emerging in the 1970s, this theory states that through its impact on economies of scale, trade can increase the variety of goods available to consumers while decreasing the average cost of those goods.
6. The most current theory was developed by Michael Porter and states that four broad attributes of a nation shape the environment in which local firms compete, and these attributes promote or impede the creation of competitive advantage.
a. Absolute advantage theory
b. New trade theory
c. Heckscher-Ohlin theory
d. National competitive advantage theory
e. Comparative advantage theory
f. Product life-cycle theory