Chapter 01: Introduction

Definition: Trade is the exchange of goods and services between two or more parties, usually in
exchange for money. It can also refer to the act of buying and selling stocks, bonds, or currency.
International trade is the exchange of capital, goods, and services across international borders or
territories because there is a need or want of goods or services.

History of International Trade

The history of international trade spans from ancient civilizations to modern times, shaped by
technological advancements, political events, and economic theories. Early trade began with the
exchange of goods like grain, textiles, and pottery across routes like the Silk Road. The medieval
period saw European powers and the Islamic world facilitating trade across Asia, the
Mediterranean, and Africa. The Age of Exploration in the 15th-17th centuries expanded European
colonial trade, while mercantilist policies emphasized wealth accumulation through exports and
colonial control. The Industrial Revolution in the 18th-19th centuries boosted trade by improving
production and transportation, and free trade ideologies gained prominence, particularly in Britain.
In the 20th century, trade was disrupted by world wars but later flourished with global agreements
like the Bretton Woods system and the rise of multinational corporations, while regional
agreements such as the EU and NAFTA further reduced barriers. The 21st century has witnessed
the rise of digital trade and global supply chains, alongside increasing trade tensions and
protectionist policies. Central to international trade are concepts like comparative advantage, free
trade, and globalization, which continue to drive economic development and shape global
relations.

Advantages and Disadvantages of Doing Trade

Advantages of Doing Trade

 1. Economic Growth
International trade drives economic expansion by increasing demand for goods and services.
Countries that engage in trade often experience faster GDP growth due to increased production
and income. Example: Export-led growth in countries like China and South Korea has transformed
their economies.
2. Access to a Variety of Goods and Services
Trade allows consumers to access products that are not produced domestically, leading to better
quality and variety. Seasonal and luxury items become available year-round due to imports.
Example: Tropical fruits in cold countries or advanced electronics in developing nations.
3. Job Creation
Trade creates jobs in manufacturing, logistics, marketing, and other sectors tied to exports and
imports. It can also boost entrepreneurship as small businesses access international markets.
Example: Bangladesh's garment industry thrives due to exports, employing millions.
4. Efficient Resource Allocation
Countries focus on industries where they have a comparative advantage, maximizing resource
efficiency. This reduces waste and increases overall productivity. Example: Saudi Arabia focuses
on oil production, while Japan focuses on technology.
5. Technology Transfer and Innovation
International partnerships expose domestic industries to advanced technologies. Competition
encourages innovation and efficiency. Example: Developing countries adopting modern
agricultural techniques from developed nations.
6. Increased Foreign Investment (FDI)
Open trade policies attract multinational corporations to invest in local markets. FDI brings capital,
technology, and jobs. Example: India attracting global tech companies through liberal trade
policies.
7. Economies of Scale
Larger markets from international trade allow companies to scale up production. This lowers
production costs and increases profitability. Example: Car manufacturers like Toyota and
Volkswagen produce in bulk for global markets.
8. Market Diversification
Trade reduces dependence on domestic markets, protecting businesses during local economic
downturns. Access to global markets ensures steady revenue streams. Example: Coffee-exporting
countries diversify markets to avoid reliance on a single buyer.
Disadvantages of Doing Trade
1. Market Dependency
Heavy reliance on foreign markets makes economies vulnerable to global economic shifts.
Political instability or recessions in trade partner countries can harm exports. Example: The 2008
global financial crisis impacted export-dependent economies.
2. Loss of Domestic Industries
Domestic businesses may collapse due to competition from cheaper foreign products. This can
lead to job losses and economic decline in certain sectors. Example: U.S. textile industries
struggling against cheaper imports from Asia.
3. Trade Imbalances
Importing more than exporting leads to trade deficits, causing debt accumulation. Persistent
deficits can weaken currency and slow economic growth. Example: The U.S. has long struggled
with a trade deficit due to high imports.
4. Income Inequality
Trade benefits often go to large corporations and wealthier segments of society. Low-skilled
workers may lose jobs due to outsourcing and automation. Example: Factory closures in Western
countries due to production shifts overseas.
5. Environmental Impact
Trade increases production and transportation, contributing to pollution and climate change.
Resource extraction for exports can harm ecosystems. Example: Deforestation in the Amazon for
agricultural exports.
6. Exploitation of Labor
Developing countries may face labor exploitation due to demand for low-cost goods. Poor working
conditions and low wages are common in export-driven industries. Example: Sweatshops in
Southeast Asia producing cheap clothing for global brands.
7. Economic Dependence
Countries reliant on specific exports risk economic collapse if global demand drops. Price
volatility in global markets can destabilize economies. Example: Oil-dependent economies
suffering during oil price crashes.
8. Cultural Erosion
Global trade can dilute local cultures as international brands and products dominate. Traditional
industries and crafts may decline. Example: Fast food chains affecting local food cultures
worldwide.
Types of Trade:
1. Internal (Domestic) Trade
This involves the buying and selling of goods and services within the boundaries of a country.
a. Wholesale Trade
Involves buying goods in large quantities from manufacturers and selling them in smaller
quantities to retailers. Example: A wholesaler purchases large quantities of rice from farmers and
sells them to grocery stores.
b. Retail Trade
Involves selling goods in small quantities directly to consumers.
Example: A clothing store selling garments to customers in a shopping mall.

2. International (Foreign) Trade

This refers to the exchange of goods, services, and capital across international borders.
a. Export Trade
Selling domestic goods and services to foreign markets. Example: Bangladesh exports ready-made
garments to the United States and Europe.
b. Import Trade
Buying goods and services from foreign countries for domestic consumption. Example:
Bangladesh imports crude oil from Middle Eastern countries.
Explain the relationship between international trade and the nation’s standard of living.
Answer:
International trade plays a crucial role in determining a nation's standard of living by influencing
economic growth, employment, and access to goods and services. The relationship between
international trade and a nation's standard of living can be explained through the following points:
1. Economic Growth
• Increased Production and Income: Trade allows countries to specialize in the production
of goods and services in which they have a comparative advantage, leading to more
efficient production and higher income.
• Higher GDP: Export-led growth can drive GDP growth, resulting in higher national
income and improved living standards.
2. Access to a Variety of Goods and Services
• Consumer Choice: International trade gives consumers access to a wider variety of
products, often at lower prices due to global competition.
• Improved Quality: Exposure to international markets encourages innovation and better
product quality.
3. Job Creation and Wages
• Employment Opportunities: Trade expansion can lead to job creation in industries with
competitive advantages, improving employment rates.
• Higher Wages: Increased productivity in export-oriented industries can lead to higher
wages, raising living standards.
4. Technological Advancement
• Technology Transfer: Trade promotes the exchange of technology and expertise, boosting
productivity and economic development.
• Innovation: Competitive global markets push domestic industries to innovate and improve
efficiency.
5. Efficient Resource Allocation
• Comparative Advantage: Countries focus on producing goods where they are most
efficient, leading to optimal resource use and higher economic output.
• Cost Reduction: Specialization and economies of scale lower production costs, benefiting
consumers.
6. Income Distribution and Inequality
• Regional Development: Trade can lead to economic development in various regions,
reducing regional disparities.
• Potential Inequality: However, without proper policies, trade can widen income
inequality, negatively impacting certain groups.
7. Foreign Investment and Infrastructure Development
• Attracting FDI: Open trade policies attract foreign direct investment (FDI), leading to
infrastructure development and industrial growth.
• Modernization: Investment in infrastructure improves productivity and living standards.
8. Economic Stability and Risk Diversification
• Market Diversification: International trade reduces reliance on domestic markets,
protecting economies from local economic downturns.
• Supply Chain Resilience: Access to multiple suppliers ensures steady availability of
goods.
Conclusion
International trade enhances a nation's standard of living by driving economic growth, expanding
consumer choices, creating jobs, and fostering innovation. However, its benefits must be balanced
with policies that address income inequality and protect vulnerable sectors.

Mercantilism: Trade Theory

Mercantilism is one of the earliest economic theories of trade, dominant from the 16th to the 18th
century in Europe. It was primarily focused on strengthening a nation's wealth and power through
strict control of trade and accumulation of precious metals like gold and silver.
Brief history of mercantilism
Mercantilism was the dominant economic theory in Europe from the 16th to the 18th century,
emphasizing the accumulation of wealth, particularly gold and silver, as the foundation of national
power. It promoted a favorable balance of trade by maximizing exports and minimizing imports
through heavy government regulation, high tariffs, and colonial expansion. European powers like
Spain, Portugal, France, and England implemented mercantilist policies to exploit colonies for raw
materials and maintain exclusive markets for their goods. This approach led to widespread colonial
exploitation, trade wars, and economic inefficiencies. Mercantilism began to decline in the late
18th century with the rise of industrialization and the introduction of free-market ideas by
economists like Adam Smith, whose Wealth of Nations (1776) criticized mercantilist practices and
advocated for free trade and economic liberalization. Although mercantilism eventually gave way
to capitalism and global trade liberalization, its influence can still be seen in modern protectionist
policies.
Concepts of Mercantilism
1. Wealth Equals Power
A nation's strength was believed to depend on its wealth, especially in gold and silver. More wealth
meant more power to fund armies, expand territories, and influence global politics.
2. Favorable Balance of Trade (Trade Surplus)
Countries aimed to export more than they imported to accumulate wealth.
Exports > Imports = Inflow of gold and silver.
Imports were often discouraged through tariffs and quotas.
3. Government Intervention
Governments heavily regulated the economy to control trade and maximize exports. Policies
included subsidies for exporters, tariffs on imports, and monopolies for domestic industries.
4. Colonial Expansion
Colonies were vital for providing raw materials and serving as exclusive markets for the mother
country. Colonies were prohibited from trading with other nations to maintain economic control.
5. Self-Sufficiency
Nations aimed to produce everything they needed domestically, minimizing imports. Imports of
essential goods were only allowed if they supported export industries.

Mercantilist Policies (Examples)

• High Tariffs on Imports: To discourage imported goods and protect domestic industries.
Example: England’s Navigation Acts restricted colonial trade to English ships.
• Subsidies for Domestic Industries: Financial support for exporters to make products
cheaper abroad.
Example: France under Jean-Baptiste Colbert supported local manufacturers.
• Colonial Exploitation: Colonies provided raw materials and consumed finished goods
from the ruling nation.
Example: British colonies in India supplied raw cotton to Britain, which exported
finished textiles back.
Criticisms of Mercantilism
Although mercantilism was a dominant economic theory from the 16th to 18th centuries, it has
faced significant criticism for its flawed economic principles and negative social impacts. Below
are the major criticisms of mercantilism:

1. Overemphasis on Wealth Accumulation (Gold and Silver Focus)

Mercantilism equated national wealth with the accumulation of precious metals. Critics argue
that wealth should be measured by a nation's productive capacity and the well-being of its
people, not just gold reserves. Adam Smith criticized this in The Wealth of Nations (1776),
highlighting that true wealth comes from efficient production and commerce.

2. Ignoring Consumer Interests

Mercantilist policies prioritized exports and restricted imports through high tariffs.
This led to higher prices and limited choices for consumers, lowering their standard of living.
Import restrictions protected inefficient domestic industries, forcing consumers to buy lower-
quality or more expensive products.

3. Inefficient Resource Allocation

Mercantilism encouraged self-sufficiency, preventing countries from specializing in industries
where they had a comparative advantage.
Resources were inefficiently allocated to industries that may not have been competitive
globally.
Example: Countries producing goods domestically at high costs instead of importing them
cheaply.

4. Suppression of Free Trade

Mercantilism rejected the idea of free trade, believing that international trade was a zero-sum
game where one nation's gain was another's loss.
Critics argue that trade can be mutually beneficial when countries specialize and trade freely.
This perspective ignored the concept of comparative advantage introduced later by David
Ricardo.
5. Colonial Exploitation and Inequality
Mercantilist countries exploited their colonies by extracting raw materials and forcing them to
buy manufactured goods from the colonizer.
This created severe economic and social inequalities between colonial powers and their
colonies.
Example: The British Empire exploited Indian resources while restricting India's industrial
development.

6. Encouragement of Trade Wars and Conflicts

Mercantilist competition for wealth led to political tensions, trade wars, and even military
conflicts.
Countries imposed tariffs and trade barriers against each other, disrupting peaceful economic
relations.
Example: European naval wars and colonial conflicts in the 17th and 18th centuries.

7. Neglect of Services and Non-Material Wealth

Mercantilism focused solely on the trade of physical goods, ignoring the value of services and
intellectual property.
Modern economies recognize that services like finance, technology, and education
significantly contribute to national wealth.

8. Short-Term Gains Over Long-Term Growth

Mercantilist policies prioritized immediate wealth accumulation rather than sustainable long-
term economic growth.
By focusing on hoarding gold and limiting imports, countries ignored investments in
infrastructure, education, and innovation.

9. Stifling of Innovation and Entrepreneurship

Heavy government control, monopolies, and trade restrictions limited competition and
discouraged innovation.
Entrepreneurs and small businesses struggled under strict regulations, reducing economic
dynamism.
10. Inflation and Economic Instability
Accumulating large amounts of gold and silver without increasing production led to inflation.
More money in circulation without a rise in goods and services caused prices to rise, harming
the economy.
Decline of Mercantilism
Mercantilism began to decline in the late 18th century as economists like Adam Smith
criticized its principles.
In "The Wealth of Nations" (1776), Adam Smith introduced the idea of free trade and
comparative advantage, arguing that wealth comes from productivity and efficient use of
resources, not just gold and silver.

The Gravity Model of International Trade: is a popular economic model used to explain the
flow of goods and services between countries. It is based on the analogy to gravity in physics,
where larger and closer bodies (like planets) exert stronger forces on one another. Similarly, in
international trade, countries that are geographically closer and have larger economies are more
likely to trade with each other.
Concepts of the Gravity Model
1. Size of Economies (GDP):
The model suggests that the volume of trade between two countries is positively related to their
economic sizes, typically measured by Gross Domestic Product (GDP). Larger economies tend to
trade more with each other due to their higher production capacities and greater demand for goods
and services.
The larger a country's GDP, the more it produces, which creates a greater range of exportable goods
and services, and also generates more demand for imports from other countries.
2. Distance Between Countries:
Trade between two countries is negatively related to the physical distance between them. The
farther apart two countries are, the less likely they are to engage in significant trade. Distance can
be a barrier due to higher transportation costs, longer shipping times, and greater logistical
challenges.
Geographic distance can also include cultural distance (language, customs) or institutional distance
(differences in legal systems, trade regulations), which can act as additional barriers to trade.
3. Trade as a Function of Economic Size and Distance:
The basic form of the Gravity Model suggests that trade flows between two countries can be
estimated using the formula:

Application of the Gravity Model:

1. Trade Prediction:
The Gravity Model can be used to predict trade flows between countries. By inputting the GDPs
of the two countries and the distance between them, the model gives an estimate of the volume of
trade. This helps in understanding how much trade is likely to occur between two countries based
on their economic size and proximity.
2. Explaining Patterns of Trade:
The model explains why certain countries trade more with each other than with others. For
example, countries with large economies like the United States, China, and Germany tend to trade
heavily with one another because of their size. Similarly, neighboring countries (such as France
and Germany or the U.S. and Canada) often engage in more trade than countries that are far apart.
3. Trade Agreements:
The model can also help explain the impact of trade agreements or regional trade blocs. Countries
within trade agreements like the European Union or the North American Free Trade Agreement
(NAFTA) often trade more with each other, despite any geographic distance, due to reduced
barriers such as tariffs and harmonized regulations.
4. Impact of Distance and Logistics:
Distance is a critical factor in trade flows. If two countries are far apart, even if they have similar-
sized economies, their trade volume may be smaller due to higher transportation and transaction
costs. The model also accounts for the fact that countries with better infrastructure and
transportation networks may overcome some of the disadvantages of distance.
 5. Cultural and Institutional Factors:
The model can also be extended to include other "distances" beyond physical space. For example,
linguistic, cultural, or institutional differences (e.g., legal and regulatory differences) can reduce
the likelihood of trade, even between geographically close countries. The Gravity Model can
incorporate these factors into its predictions.
Extensions and Modifications:
While the basic Gravity Model is useful, it has been extended in various ways to account for factors
such as:
1. Multilateral Trade Effects:
The basic model assumes bilateral trade between two countries, but in reality, trade flows are often
influenced by many countries. The multilateral extension of the Gravity Model accounts for trade
between multiple countries simultaneously, considering not just bilateral distance and economic
size, but also indirect effects that may arise from third-party countries.
2. Free Trade Agreements and Customs Unions:
Countries within a trade bloc, like the European Union (EU), have reduced barriers to trade, which
increases the volume of trade even between distant countries. The Gravity Model can be modified
to account for the impact of such agreements by adjusting the "distance" factor to reflect lower
trade costs among member countries.
3. Quality of Infrastructure:
The model can also integrate the quality of transportation, communication, and trade infrastructure,
which can make trade between countries more efficient even if they are geographically distant.
4. Trade Policies and Tariffs:
Trade policies (such as tariffs, quotas, and export subsidies) can be included in the Gravity Model
to examine their effect on trade flows. A higher tariff barrier increases the "distance" between two
countries in terms of trade costs, thereby reducing the volume of trade.
Limitations of the Gravity Model:
a. Assumption of Rational Behavior: The Gravity Model assumes that trade flows are
driven solely by economic size and distance. It does not fully account for the influence of
political, historical, or institutional factors (such as past trade relationships or geopolitical
factors) that can shape trade patterns.
b. Simplified Representation of Distance: The model typically uses physical distance as a
proxy for all trade barriers, but in practice, trade barriers go beyond just geography,
including cultural, legal, and economic factors.
c. Static Nature: The basic form of the Gravity Model is static and does not account for the
dynamic changes in trade patterns over time, such as the effects of technological
advancements in transportation or the emergence of new trade agreements.