Chapter 10: Trade in China, India, and Japan
Trade theory goes back to Adam Smith in 1776 and to David Ricardo in 1826. These theories developed the concept of free trade and stressed the advantages of trade. While Smith laid the foundations of the theory, Ricardo developed the theory of comparative advantage (as discussed in Chapter 2) that we continue to use today. Mills and Marshall both contributed to trade theory. However, the theory put forward by Eli Heckscher and Bertil Ohlin became a dominant theory in the 1930s. This theory was based on the idea of opportunity cost, or utility of foregone consumption. Heckscher–Ohlin theory states that countries will import products whose factors of production are scarce and export products whose factors of production are abundant. This theory viewed free trade as Pareto optimal, or optimizing of production, consumption, and exchange for two trading nations at equilibrium (Sen 2010). Heckscher–Ohlin theory placed resource endowments of nations as the determining factor of international trade. Consumer preferences determine commodity and factor prices. Then, with identical consumer preferences between two trading nations, factor endowments determine how price competitive traded goods are.
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