International Trade
Failed Theories
Mercantilism (trade surplus, govt
intervention, colonization, wealth
focus)
Factor proportion theory (he who has
most capital sells capital intensive
goods) vs. Leontief paradox
Absolute advantage
Market and government failure
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International Business 3e
Chapter 5 - 2
New Trade Theory
Flows (income) vs. stocks (wealth)
Government- the loser chooser
(industrial policy: favor squeaky wheel)
Comparative advantage
Learning curve vs. first mover
advantage
Resource quality vs. quantity
Game Theory: the prisoner’s dilemma
© Prentice Hall, 2006
International Business 3e
Chapter 5 - 3
Chapter 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
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International Business 3e
Chapter 5 - 4
World’s Top Exporters
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International Business 3e
Chapter 5 - 5
Trade Patterns
Merchandise trade among:
Low- and
middle-income
nations
6%
Western European
trade is mostly intraregional trade
High-income
nations
60%
North America
imports twice as
much from Asia as it
exports to Asia
34%
High-income and low- and
middle-income nations
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International Business 3e
Chapter 5 - 6
Who Trades with Whom?
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International Business 3e
Chapter 5 - 7
Trade Theory Timeline
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International Business 3e
Chapter 5 - 8
Mercantilism
Nations accumulate financial wealth by
encouraging exports and discouraging imports
Three pillars
• Maintain trade
surplus
• Government
intervention
• Exploit colonies
© Prentice Hall, 2006
Inherent flaws
• World trade is
zero-sum game
• Constrains output
and consumption
• Limits colonies’
market potential
International Business 3e
Chapter 5 - 9
Absolute Advantage
Ability of a nation to produce a good more efficiently than any
other nation (greater output using same or fewer resources)
Riceland
1 resource unit = 1 ton rice or
1/5 ton tea
Tealand
1 resource unit = 1/6 ton rice or
1/3 ton tea
Specialization and trade allows each to
produce and consume more
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International Business 3e
Chapter 5 - 10
Trade Gains:
Absolute Advantage
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International Business 3e
Chapter 5 - 11
Comparative 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
Riceland
1 resource unit = 1 ton rice or
1/2 ton tea
Tealand
1 resource unit = 1/6 ton rice or
1/3 ton tea
Specialization and trade allows each to
produce and consume more
© Prentice Hall, 2006
International Business 3e
Chapter 5 - 12
Trade Gains:
Comparative Advantage
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International Business 3e
Chapter 5 - 13
Assumptions and Limitations
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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
International Business 3e
Chapter 5 - 14
Factor Proportions Theory
Countries produce and export goods that require
resources (factors) in abundance, and import goods
that require resources in short supply
Labor
Land and Capital
Two factor types
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International Business 3e
Chapter 5 - 15
Leontief Paradox
Research discovered evidence opposite the
prediction of factor proportions theory
 US exports are more labor-intensive than US imports
Possible explanation
 Theory assumes nation’s production
factors to be homogeneous
 Theory is better predictor when
expenditures on labor are considered
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International Business 3e
Chapter 5 - 16
International Product Life Cycle
A company begins by exporting its product and later undertakes
foreign direct investment as a product moves through its life cycle
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International Business 3e
Chapter 5 - 17
New Trade Theory
Fundamentals

Gains from specialization
and increasing economies
of scale

Companies first to market
create barriers to entry

Government may help by
assisting home
companies
© Prentice Hall, 2006
First-mover advantage

Economic and strategic
advantage of being first to
enter an industry

May create a formidable
barrier to market entry for
potential rivals
International Business 3e
Chapter 5 - 18
National Competitive Advantage
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 conditions
Demand conditions
Related and supporting industries
Firm strategy, structure and rivalry
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Chapter 5 - 19
Factor Conditions
Basic factors
Advanced factors
Nation’s resources
Result of investing in
education and innovation
(large workforce, natural
resources, climate and
surface features)
(skill of workforce segments,
technological infrastructure)
Basic factors can spark initial production, but advanced
factors account for sustained competitive advantage
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International Business 3e
Chapter 5 - 20
Demand 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
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International Business 3e
Chapter 5 - 21
Related and Supporting Industries
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
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International Business 3e
Chapter 5 - 22
“With the technology and techniques available in the early
‘80’s, the sequence would have taken 100 years to complete.
By the early ‘90s, 2010 was thought to be a more likely date.
Three years ago, the target was set on 2005.
“ In May 1998, Venter announced he would head a new
company and, using a different method of sequencing, beat
the Human Genome Project to its goal.”
EXAMPLE: (KC Star June 27, 2000, p. A1)
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International Business 3e
Chapter 5 - 23
Year
of 1980
technology
1990
1997
2000
Years
to 100 years
complete
20 years
8 years
2 years?
Job size (# G
of genes)
G
G
G
Average
Cost
20/G
8/G
2/G
100/G
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Chapter 5 - 24
120
100
80
60
40
20
99
97
95
93
91
89
87
85
83
81
ea
r
0
Y
Average Cost (Time/Gene)
Learning Curve
Year
© Prentice Hall, 2006
International Business 3e
Chapter 5 - 25
Firm Strategy, Structure
and 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
© Prentice Hall, 2006
International Business 3e
Chapter 5 - 26