Chapter 4 - 1

International Trade International Trade TheoryTheory

Chapter 4 - 2

Chapter PreviewChapter Preview

• Discuss the volume and patterns of world trade

• Identify the inherent flaws of mercantilism

• Explain the absolute and comparative advantage theories

• Describe the factor proportions and international product life cycle theories

• Explain the new trade and national competitive advantage theories

Chapter 4 - 3

International TradeInternational Trade

Purchase, sale or exchange of goods and services across national borders

People have larger selection of products Important engine for job creation

People have larger selection of products Important engine for job creation

Chapter 4 - 4

Trade and World OutputTrade and World Output

• World trade• 80% merchandise• 20% services

• World output impacts trade• Growing output = growing trade• Sluggish output = sluggish trade

• World trade grows faster

than world output

Chapter 4 - 5

World’s Top ExportersWorld’s Top Exporters

Chapter 4 - 6

Trade PatternsTrade Patterns

60%

34%

6%

Merchandise trade among: Western European trade is mostly intra-

regional tradeLow- and middle-income nations High-income

nations

High-income and low- and middle-income nations

North America imports twice as

much from Asia as it exports to Asia

Chapter 4 - 7

Who Trades with Whom?Who Trades with Whom?

Chapter 4 - 8

Trade and theTrade and theDependent NationDependent Nation

Totaldependence

Potential effects of dependence:

+ Infuses needed capital+ Creates jobs and raises wages+ Imports technology and skills

– Economic problems transferred– Political turmoil can spill over

Totalindependence

Chapter 4 - 9

Trade Theory TimelineTrade Theory Timeline

Chapter 4 - 10

MercantilismMercantilismNations accumulate financial wealth byNations accumulate financial wealth byencouraging exports and discouraging encouraging exports and discouraging

importsimports

Three pillarsThree pillars• Maintain trade

surplus

• Governmentintervention

• Exploit colonies

Inherent flawsInherent flaws• World trade is zero-sum game• Constrains output and consumption• Limits colonies’ market potential

Chapter 4 - 11

Absolute AdvantageAbsolute Advantage

Ability of a nation to produce a good more efficiently than any other nation (greater output using same or fewer resources)

Specialization and trade allows each to produce and consume more

1 resource unit = 1 ton rice or

1/5 ton tea

RicelandRiceland

1 resource unit = 1/6 ton rice or

1/3 ton tea

TealandTealand

Chapter 4 - 12

Trade Gains:Trade Gains:Absolute AdvantageAbsolute Advantage

Chapter 4 - 13

Comparative AdvantageComparative Advantage

Inability of a nation to produce a good more efficiently than other nations, but an ability to produce that good more efficiently than it

does any other good

Specialization and trade allows each to produce and consume more

1 resource unit = 1 ton rice or

1/2 ton tea

RicelandRiceland

1 resource unit = 1/6 ton rice or

1/3 ton tea

TealandTealand

Chapter 4 - 14

Trade Gains:Trade Gains:Comparative AdvantageComparative Advantage

Chapter 4 - 15

Assumptions and LimitationsAssumptions and Limitations

1. Nations strive only to maximize production and consumption

2. Only two countries produce and consume just two goods

3. No transportation costs of trading goods

4. Labor is the only resource used to produce goods

5. Ignores efficiency and improvement gains from producing just one good

Chapter 4 - 16

Factor Proportions TheoryFactor Proportions Theory

Countries produce and export goods that require resources (factors) in abundance, and import goods

that require resources in short supply

Two factor types

Land and Capital Labor

Chapter 4 - 17

Leontief ParadoxLeontief Paradox

Research discovered evidence opposite the prediction of factor proportions theoryUS exports are more labor-intensive than US imports

Research discovered evidence opposite the prediction of factor proportions theoryUS exports are more labor-intensive than US imports

Possible explanationPossible explanation Theory assumes nation’s production

factors to be homogeneous

Theory is better predictor when expenditures on labor are considered

Possible explanationPossible explanation Theory assumes nation’s production

factors to be homogeneous

Theory is better predictor when expenditures on labor are considered

Chapter 4 - 18

International Product Life International Product Life CycleCycle

A company begins by exporting its product and later undertakes foreign direct investment as a product moves through its life

cycle

Chapter 4 - 19

New Trade TheoryNew Trade Theory

FundamentalsFundamentals

Gains from specialization and increasing economies of scale

Companies first to market create barriers to entry

Government may help by assisting home companies

First-mover advantageFirst-mover advantage

Economic and strategic advantage of being first to enter an industry

May create a formidable barrier to market entry for potential rivals

Chapter 4 - 20

National Competitive National Competitive

AdvantageAdvantageNation’s competitiveness in an industry depends on the industry’s capacity to

innovate and upgrade, which in turn depends on four main determinants(plus government and chance)

Nation’s competitiveness in an industry depends on the industry’s capacity to innovate and upgrade, which in turn depends on four main determinants

(plus government and chance)

Factor conditionsFactor conditions

Demand conditionsDemand conditions

Firm strategy, structure and rivalryFirm strategy, structure and rivalry

Related and supporting industriesRelated and supporting industries

Chapter 4 - 21

Factor ConditionsFactor Conditions

Basic factors Advanced factors

Nation’s resourcesNation’s resources(large workforce, natural resources, climate and

surface features)

Nation’s resourcesNation’s resources(large workforce, natural resources, climate and

surface features)

Result of investing in Result of investing in education and innovationeducation and innovation

(skill of workforce segments, technological infrastructure)

Basic factors can spark initial production, but advanced factors account for sustained

competitive advantage

Chapter 4 - 22

Demand ConditionsDemand Conditions

Sophisticated home-market buyers drive companies to

improve existing products and develop entirely new products

and technologies

This should improve the competitiveness of the entire

group of companies in a market

Chapter 4 - 23

Related and Supporting Related and Supporting

IndustriesIndustriesRelated and Supporting Related and Supporting

IndustriesIndustries

Companies in an internationally competitive industry do not exist in isolation

Supporting industries form “clusters” of economic activity in the geographic area

Each industry reinforces the competitiveness of every other industry in the cluster

Chapter 4 - 24

Mapping U.S. ClustersMapping U.S. Clusters

Chapter 4 - 25

Firm Strategy, StructureFirm Strategy, Structureand Rivalryand Rivalry

Highly skilled managers are essential because strategy has lasting effects on firm competitiveness

Domestic industry whose structure and rivalry create an intense struggle to survive, strengthens its competitiveness

Chapter 4 - 26

• This chapter presents the main theories that developed over time to explain the occurrence of international trade following a brief overview of trade benefits, volume, and patterns. Mercantilism states that nations should accumulate financial wealth, usually in the form of gold, by encouraging exports and discouraging imports. Absolute advantage states that a nation should concentrate in the production and export of those products in which it has an absolute advantage and import products it needs but does not produce. Comparative advantage states that trade will still benefit two countries even if one country is a less efficient producer. Factor proportions theory states that countries produce and export goods that require resources (factors) that are abundant and import goods that require resources in short supply. The international product life cycle theory states that a company will begin by exporting its product and later undertake foreign direct investment as the product moves through its life cycle. The new trade theory argues that 1) there are gains from specialization and increasing economies of scale, 2) companies first in a market create barriers to entry, and 3) governments can assist their home-based companies. National competitive advantage theory states that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade.

Chapter SummaryChapter Summary

Thanks Thanks