hello and welcome to my channel so we are continuing with the playlist on International Trade Finance already 15 videos are uploaded under this playlist so kindly click on the link to the playlist to get a broader understanding of all the topics covered and today's topic for learning is theories of trade Finance you can get the link to the playlist on the I button in the description box as well as at the end of this video now let's start with all the theories that we are going to cover in this particular video the theories that we are going to cover in this video are mentioned over here so the first one is the theory of absolute Advantage second is the theory of comparative advantage third one is the hexer orine theory and the fourth one is Factor price Equalization Theory so it will be more easier that we will try to understand all these four theories with some examples which you can relate to and and see how the basis of international trade came into existence what all were the theories given by these famous economist starting with the first one the theory of absolute Advantage so this was introduced by Economist Adam Smith and the the simply focuses on benefit of specialization and trade now one thing you need to consider that all these theories are based on certain assumptions and there are many limitations to the Theory this was provided to form a basic idea of how International Trade can exist and how Advantage can be taken but given that whenever theory is given there are limitations and assumptions related which is not practical in a real world scenario but to get a B uh to get a basic understanding on how business was started how international trade some basic Foundation was set up these theories Pro to be very useful at that particular point of time now we will discuss about the uh assumptions at in the last slide that what all assumptions were made first we will try to understand that what these theories focuses on and what was the main point Main uh concept provided under each of these Theory so the absolute Advantage theory is focusing on the benefit of specialization and trade now you need to consider that in all these four theories whenever we are talking about we are considering two countries into existence and there are two goods which are being exchanged with between these two countries Here Comes our first limitation that we are considering that uh there are only two countries involved and they are exchanging two of the products in which they are having specialization in but keeping the limitations aside you need to understand what was the basic motive of this particular Theory so it said uh let's understand this with an example so uh for example there are two countries Brazil and India Brazil has more speciality in production of coffee while India has more speciality in production of pulses now if we go according to this Theory so Brazil is having an absolute advantage in coffee production while India is having an absolute advant Vantage in pulses production uh you can consider different factors for this reason maybe the climatic condition maybe the resources that are available keeping all those things in align one of the country is having that expertise in coffee production another country is having the expertise in pulsus production now according to this Theory the country where it is having it its absolute Advantage should focus on producing only that product and for other product it can trade with another country so in this case India should be producing pulses and Brazil should be producing coffee and then both these country can uh do trade with each other which means that coffee can be uh coffee can be exported from Brazil to India and pulses can be exported from India to Brazil so both can form a trade alignment deciding that I will be producing the thing that I have my specialization you produce the thing that you are having your specialization in this way we both can lower our cost and we both can fulfill the need of each other countries so this was the basic idea uh provided in this theory of absolute advantage that you should take benefit of your specialization where you are having absolute Advantage because if you know the skill if you are having the proper climatic condition if you are having the available res sources for production of one particular commodity you should grow that commodity on a large scale and another product in which you don't have that much skill or that particular favorable condition you can be you can easily import that from another country because if you are going to produce all the products on your own you will be incurring more cost you are not having absolute advantage in every of the product so the good in which you are having absolute Advantage you produce that good and for and if you want to import other products you just do a trade off with other country and get the product imported while exporting the product which you have made with your absolute Advantage so in this way it's said that both countries can gain from their relative trade advantage now let's just read this once to make it more clear if a country can produce certain Goods at a lower cost because availability of resources like labor raw material and production capacity is better than other countries then it has an absolute advantage and can trade the same with another country for import of other Goods that it does not have specialization in producing okay so you need to understand the crisp behind this Theory which was that you you don't need to incur cost on producing things in which you are not having that particular skill set you can depend on other countries and you can import that good you should focus on producing things that you are good at which is taking benefit of your absolute Advantage now uh as I said there were many limitations to these theories one such limitation uh is that it is considering that uh let's take our example again so Brazil is producing coffee India is producing pulses but what is the exact value if we are exchanging the same quantity of pulses with same quantity of coffee is it having a fair value is it having a fair exchange value so value was not mentioned in this particular Theory it was uh it was lacking over there or we can say that it doesn't explain about the trade pattern and its applic applicability is also limited to Modern economy where there is diversification in Technology Innovation and process maybe you are having favorable condition but we are having the technology with which we can produce at a larger scale so in modern economy it won't be applicable but again this Theory's main purpose was to give you a basic idea that you should take advantage of your specialization and export goods to earn income on better better money and further you can import those goods which you are not able to produce at a lower [Music] cost now let's come to our second theory which is is the theory of comparative advantage this theory was given by Economist David Ricardo this Theory suggested that even if one country doesn't have an absolute advantage in producing any particular good it can still benefit from comparative advantage now see our first theory was talking about absolute advantage that you are specialized in one particular thing in producing one particular good but what if a country is not specialized in producing any particular good it it does not have speciality in producing any particular good it is not having an absolute Advantage another country is having that absolute advantage in two or three products maybe so how to bring that trade again between the two countries so this explained this was explained in the theory of comparative advantage now it says uh but before proceeding I think we should again take an example which was would make this uh really clear and uh this example I just uh uh read on internet which was very good and easy to understand so I will quote the same example so that you can also understand it easily so we are taking an individual's example not not on the basis of country so suppose uh just take the example of a famous basketball player who is Michael Jordan now beside being a famous basketball player a good basketball player he's also a fastest typist giving him an absolute Advantage so Michael Jordan is also uh is a famous basketball player is a very good basketball player and also known for his typing speed is also one of the fastest typist now he is having absolute advantage in both of these skill so here we will talk about opportunity cost if Jordan is engaging himself in typing at activity uh being good at typing practices if he is engaging him himself in typing activity he will lose a large income that he can earn within that particular time by playing uh basketball so he is losing on the income that he can gain from playing of basketball and uh and earning from that so here is the opportunity cost involving whenever he is doing typing Act it he knows he is good at that but the income if we compare so the income earned from basketball is far higher than being a typist so here Michael Jordan has to compromise with one of his absolute Advantage so if he want to utilize his time for one particular activity he will have to uh he will have to give up on typing activity and he will have to pursue his basketball activity because he knows that the earning is higher on that particular uh on that particular activity now opportunity cost of losing the another one is less over here so in turn he can uh hire one typist who can do the typing activity for for him and the typist will be having a comparative advantage now comparative advantage does means the ability of one to produce a particular good at lower opportunity cost compared to other country country so suppose one country is able to produce both of these products again taking our own example that Brazil was producing coffee and India was producing pulses now suppose given uh assuming that Brazil was good in both of those Productions uh they can also produce coffee very they they were having absolute advantage in producing coffee also they were having absolute advantage in producing uh what we say pulses also while India was not having absolute Ute advantage in producing any of these now in that case what exactly should Brazil do if we are supposing that there are only two countries and there are only two goods which have to be exchanged between the both so if the Brazil is engaging himself in producing both the things uh then another country is lacking of that particular opportunity and here Brazil is totally uh is not taking the maximum benefit out of the production capacity now Brazil is uh is both in good uh is good in both prod production of coffee as well as pulses but can decide on the opportunity cost now opportunity cost talks about that uh uh what do we say opportunity cost uh talks about how much will you lose if you give up on one particular activity so Brazil decided that okay I will be producing coffee only even if I know that uh India cannot produce pulses as better than uh as I do but I will still give this activity to India so that he will be engaging the time is limited the resources are limited I need to focus on the better resources I'm having absolute advantage in both of those things but I am better at Coffee production uh when compared so it was an internal comparison in between inside the country so me being a country I'm good at producing both the things but one uh commodity I'm producing better than the other and I'm getting the higher value than the other so I'll be focusing on one commodity only and I'll be giving up on another commodity I will be uh giving this responsibility to the another country that you produce this particular thing and then we will be trading off with each other so this was about comparative advantage where one party is having both the absolute advantage of both the goods but still it provides that that opportunity to the another country where the loss of a particular country is less so it will be uh what do we say that uh it is like uh you are delegating delegation of work so you have to delegate one of your work to another so that you can trade with each other and time can be utilized and there could be efficient trade between both the country so the theory of comparative advantage shows that even if a country enjoys an absolute advantage in the production of goods trade can still be beneficial to both the trading partners I hope it's clear with the example that we took that Michael Jordan was good in both basketball playing and at the typing speed but if have to choose between one between the uh between one of the both he will be chewing he will be choosing to play basketball because he can earn more over there and he will be delegating the typing work to another person and thus the balance can be maintained so the same concept applies under this comparative advantage analysis again it is having its own limitations as I said that these theories are based on certain assumptions and the limitations uh where we are taking just example of two countries and we are uh also taking the uh assumption that the market which exist is a perfect competition where there are are many sellers and buyers but everyone is having that equal resources and equal equal opportunities and not one country can have Monopoly over any one production of goods so Monopoly concept is not there assuming that there is perfect competition concept and the resources are fully utilized and the time is being fully uh utilized now let's move to our third Theory which which is the hexer oene theory this was introduced by The Economist Ellie hexer and bertil oene jointly and thus it is known also as Factor proportions Theory okay so this Theory gives an idea on the basis of factors of production now uh factors of production means uh the things that are involved in production of a particular commodity so if you are in a man manufacturing process labors are involved resources are involved raw materials are involved so there are certain factors which are involved which are in a particular production process now this theory was based on idea that countries will export goods that use their abundant factors of production more intens intensively so it says that suppose again there are two countries one country is having uh abundant of one particular Factor another country is having abundant of another factor of production so again let's take an example talking about Korea and USA So Korea is having a lot of Labor so it is also referred as a labor intensive country however us is having a lot of capital so it is referred as capital intensive country so keeping that uh keeping that fact in consideration if there are two countries one is having a abundant of Labor another is having abundant of capital so they should be producing the goods that they are having an edge with the factor of production so uh in this example Korea should be producing labor intensive Goods they should be producing Goods where there are more labor requirement and us should be focusing on Capital intensive Goods that's that's what where there are the goods which involve a lot of capital A lot of finances involved over there and after that taking benefit of each of the Abundant factor of production both the countries can trade between each other so if we are uh just understand that Capital intensive means like producing of machines and equipments and uh where there are requirement where a lot of capital investment is required to produce Goods while labor intensive Goods means where there is lot of large number of labors are required to carry out production like if we take examples Capital intensive products could be manufacturing of automobiles steel production telecommunication labor intensive activities can be agriculture mining Food Services Hospitality Etc so one country can engage itself in agricultural production another country can engage itself in steel production and then they both can trade between each other so this Theory establishes and focuses on factors of production which says that if your fact if you are having an edge over one particular Factor you should use the best of that if if another country is having Edge over another factor of production they should be using that particular Edge and then the trade can be done between both the countries coming to our next Theory the factor price Equalization Theory under absolutely free trade the price of traded products as well as the price of factors of production such as labor land and capital will be equalized among countries now this Theory uh tried to explain that over a longer period of time this fact taking advantage of the factor of production will not be useful because over a long period of time the uh uh this won't be an advantage uh this won't be an advantage because of the mobility of factors of production now suppose if one country H has more of factor like labor and another country has less labor but they are better in capital as we took the example of Korea and USA So Korea was having a lot of Labor and USA was having a lot of capital so it can provide better wages however in Korea the labor were not getting enough wages paid so if we are considering that these factors can have mobility and they can move from one place to another so in free movement scenario the labors from Korea will be moving to USA and then they will for better wages for better uh uh for better earning over there and in a long run the uh the concept of taking advantage of one particular factor of production will be in vain because the movement is now there keeping the opportunities looking at the opportunities the factor of production can be moved from one place to another thus due to movement of factor this will no more be able to produce a comparative advantage for one particular country so the factor price Equalization Theory said that in long run when factors will start moving from one country to another country one particular country will not having that absolute or comparative advantage over one single Factor now let's see certain assumptions of international trade theories so the first one is that these theories consider two countries two goods model which is not applicable in real scenario we are talking about global world where there are many countries where there are large number of products and services so making uh theories on the basis of two countries and two particular Goods is not giving a practical real scenario of course it can be used to derive certain basic understanding but not totally applicable in Practical Market World constant return to scale these theories also assumed that if I am having uh uh for example if I am having 10 workers and I'm able to produce uh like 10 kgs of certain good then when I'll be having 20 workers which is double the times I'll be able to produce 20 kg 20 kgs of that particular good so it assume that there will be constant return to scale as I will be increasing my labor the similarly my production will be increasing with a constant fixed term does it happen in real scenario if you are uh just if you just keep on increasing your employees will it help in increasing your productivity it doesn't work that way there is not a constant return to scale that every time you are multiplying with the same return so these theories were based on constant return to scale that if I'm having advantage in one particular thing and I'm using it uh using it on benefit purpose multiplying it then I'll be having the same increasing returns likewise but it doesn't happen in real Market real economical scenario fixed resources and constant Technologies so these theories were also based on assumption that one country is having one particular resource and the technology is constant between both the countries so both the countries having the same level of Technology there is no innovation there is no skill set they know uh equally the same and they are having fixed resources that can be utilized then it assume that there is perfect competition even if one country is having Edge in producing two of the goods uh equally equally better and efficient way it cannot create its Monopoly assuming that there is perfect competition there are large number of buyers and sellers having equal opportunities so there cannot be Monopoly created in the market one of the Assumption was also that there is full employment so if a country is having uh uh if a country is having uh X number of resources all the X number of resources are being utilized there is a concept of full employment however this is not again applicable in Practical real scenarios so these were certain assumptions which were behind the international trade theories it comes with its own limitations but this theory was one upgradation to the previous one so if we took an example of absolute Advantage it it basically mentioned that if you are specialized in one thing you can trade off with another thing again we talked about what if if what if I am not having specialization in any of the thing you can still have a comparative advantage because even if person is having all the skill set and and another person is not having but one person is not uh will not be able to utilize all his skills on by himself so he will have to delegate and the another person will again gain a comparative advantage so this was comparative advantage in case you are not having an absolute Advantage then third Theory mentioned about the factors of production that if you are having the factors of production you can focus on that that which factor of production is you are uh exhaling in and you can use that to produce the resources so that you the basic idea was that you can reduce your cost if something you are good at if something you can produce uh at your because of the favorable condition or because of the cheap labors that are available you will be incurring less cost and thus you can maximize your profit together with the collaboration with another another country so it mentioned about the factor of production and then the another theory suggested that what if the factors of production will start moving in that case there will be an equalization over a long period of time if there will be Mobility if there will be movement so these were the theories I hope it was a bit clear in your understanding if you like the video do hit the like button and do not forget to subscribe to channel thank you so much for watching