Assignment 10 INTERNATIONAL TRADE THEORY AND

DEVELOPMENT STRATEGY
A. Briefly summarize the major conclusions of the traditional theory of free trade with regard to its
theoretical effects on world and domestic efficiency, world and domestic economic growth, world and
domestic income distribution, and the pattern of world production and consumption.

- By concentrating on the production of those goods they can produce at a lower opportunity
cost and importing the commodities whose production has a greater opportunity cost, free trade
enables the different countries to capitalize on their comparative advantages. This makes it possible
for a nation to utilize its resources effectively, which in turn promotes effective resource usage
throughout the world.

Free trade-friendly nations tend to develop more quickly, innovate, increase productivity, and
give their citizens better wages and more chances. By providing consumers with more cheap
goods and services, free trade also benefits those with lower incomes. Economic growth and
poverty reduction are aided locally and worldwide by integrating with the global economy through
trade and global value chains.

Trade and inequality and trade and income have substantial correlations between countries,
but it is difficult to determine cause and effect because of endogeneity issues. Higher trade
openness—measured as GDP exports plus imports—is associated with higher living standards and
less income disparity. However, given that numerous factors that directly affect income and
inequality may also be connected with trade itself, it is debatable whether trade openness is
endogenous in these straightforward bivariate connections. For instance, nations that adopt open
trade policies may also pursue other domestic policies that are oriented toward the market and
implement stable fiscal and monetary policies. Since these policies are likely to affect income and
inequality, trade openness is likely to be correlated with important factors that are omitted from the
naïve approach.

B. Proponents of free trade, primarily developed country economists, argue that the liberalization of
trading relationships between rich and poor countries (the removal of tariff and nontariff barriers) would
work toward the long-run benefit of all countries. Under what conditions might the removal of all tariffs
and other impediments to trade work to the best advantage of developing countries? Explain.

- First, proponents of free trade contend that a liberalization of commercial relations between
wealthy and underdeveloped nations will result in long-term gains for all nations. This is due to the
fact that free trade enables more effective resource allocation, increased competition, and access
to bigger markets, all of which can contribute to greater economic growth and development. The
elimination of all trade barriers, including tariffs, may not, however, inevitably help developing
countries' economies. This is due to the possibility that developing countries won't be as competitive
as developed ones and won't be able to compete on an even playing field. Jobs could be lost as a
result, which could have detrimental social and economic repercussions. This could also result in
the displacement of regional industries. Additionally, the elimination of tariffs and other trade
barriers may result in a reduction in government revenue, which may affect developing countries'
capacity to finance the social and infrastructural projects essential for economic progress.
C. Traditional free-trade theories are based on six crucial assumptions, which may or may not be valid for
developing nations (or for developed nations for that matter). What are these crucial assumptions, and
how might they be violated in the real world of international trade?

- When there are no government restrictions placed on the imports and exports of goods and
services, that trade is referred to as free trade. Both nations gain from free commerce, which also
boosts global productivity. The specialization of a good results in the comparative advantage.
Because prices are low and the goods are of higher quality, consumer welfare increases.

The theories of free trade describe how trade is advantageous for nations. Additionally, it
displays the elements that result in comparative advantage. When the opportunity cost of
manufacturing a good is cheaper in one nation than in another, that country has a comparative
advantage over other countries. When a nation focuses on a good in which it has a comparative
advantage, trade benefits that nation.

The crucial assumption of free trade theories is:

1. Perfect competition: It assumes perfect competition in all the markets which means the product
is homogeneous, information is perfect and there is free entry and exit in the market.
2. Two goods: There are only two goods produced in the economy and one good is exchanged for
other goods and there is no money involved. The barter system prevails in the economy.
3. Two countries: The theories show the trade between only two countries to make the model
simple.
4. International factor immobility: The factor of production such as labour is not mobile across
countries and cannot move freely internationally.
5. Fixed Technology: Technology is fixed in the country and cannot grow over a period of time.
6. No government interference: The government has no restriction in trade.

Because there can be monopolies, monopolistic competition, and oligopolies on the market
instead of perfect competition, all the assumptions made about the real world are inaccurate. In the
actual world, more than two countries trade and numerous different items are produced by each
nation. The technology advances over time as a result of research and development spending. In
the actual world, the government regulates the market and sets quotas and tariffs.