Chapter Six
International Trade Theory
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International Business 10e Daniels/Radebaugh/Sullivan
International Business
Chapter Objectives
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Explain trade theories
Discuss how global efficiency can be
increased through free trade
Introduce prescriptions for altering
trade patterns
Explore how business decisions
influence international trade
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General Types of Trade Theories
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Descriptive: the natural order of
trade
• Tolerant conditions
• Which products, how much, and with
whom a country will trade in the
absence of restrictions
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Prescriptive: questions whether
governments should interfere with
the free movement of goods and
services
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Mercantilism
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Initial trade theory that formed the
foundation of economic thought from 1500
– 1800
Based on concept that a nations wealth is
measured by its holding of treasure (gold)
Nations often imposed restrictions on
imports since they did not want “their”
treasure moving to another country to pay
for the imports
It was also advantageous to run a trade
surplus with “colonies”
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Mercantilism Terms
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Favorable balance of trade: country is
exporting more than it is importing
Unfavorable balance of trade: country is
importing more than it is exporting, i.e. a
trade deficit
Neomercantilism: current term to describe
the approach of countries that try to run
favorable balances of trade to achieve
some social or political gains
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Absolute Advantage
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Absolute advantage
holds that different
countries produce
some goods more
efficiently than other
countries
Thus, global efficiency
can be increased
through international
free trade
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Country Specialization
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Under the concept of absolute
advantage countries could
increase efficiency because:
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Labor could become more skilled by
repeating the same tasks
Labor would not lose time in switching
from the production of one kind of
product to another
Long production runs would provide
incentives for the development of
more effective working methods
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Natural Advantage
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Countries have inherent advantages
• Climate
• Natural resources
• Labor forces
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Two countries that have opposite
natural advantages should favor
trade with one another
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Acquired Advantage
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Most contemporary trade is manufactured goods
and services rather than agricultural goods or
natural resources
An acquired advantage represents a distinct
advantage in skills, technology, and assets that
yields differentiated products and/or costcompetitive products.
Countries with an acquired advantage produce
manufactured goods and services competitively
• Product technology
• Process technology
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Absolute Trade Advantage
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Figure 5.2
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Comparative Advantage
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There are still global gains to be made if a country
specializes in products it produces more efficiently than
other products
Regardless of whether other countries can produce those
same products even more efficiently.
Comparative Advantage: - A country can maximize its own
economic well-being by specializing in the production of those
goods and services it can produce relatively efficiently and enhance
global efficiency through its participation in unrestricted free trade.
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Analogous Explanation
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Production Possibility example
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Comparative Advantage
Figure 5.3
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Basic Assumptions and Limitations of the Theories
of Specialization
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Full employment
Economic efficiency is sought
Division of gains
Two countries/two commodities
Transportation costs
Mobility
Statics and dynamics
Services
Country size/variety of resources
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Factor Proportions
The composition of a country’s trade depends on both
its natural and acquired advantages.
Acquired advantage
“Factor-Proportions Theory”:
 Differences in a country’s relative endowments
of land, labor, and capital explain differences in
the cost of production factors.
 A country will tend to export products that
utilize relatively abundant factors of production
because they are relatively cheaper than scarce
resources.
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Production Technology
When the same product can be produced by different
methods, choosing the location of production will
depend on the production cost in each location.
The cost of production depends on the mixes between labor and
capital.
Large economies are more likely to produce goods that use
technologies requiring long production runs. This is because they
develop industries to serve their large domestic markets and,
therefore, become competitive in export markets.
Product Technology
Most new products originate in high-income countries. This is
because manufacturing depends on acquired advantages (mainly
technology), plus large amounts of capital investment.
On the other hand, lower-income countries depend more on the
production of primary products, which in turn depend more on
natural advantages.
With Whom Do Countries Trade?
• High-income countries trade primarily with each other.
• Emerging economies export primary and labor-intensive products.
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Country-Similarity Theory
When a firm develops a new product in response to observed
conditions in its home market, it is likely to turn to those
foreign markets that are most similar to its domestic market,
when commencing its initial international expansion activities.
So much trade is taking place among industrialized countries
because of:
The growing importance of acquired advantages (skills &
technology).
Markets are large enough to support new product introductions.
Cultural similarity.
Historical and political relationships, as well as economic
agreements.
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The Dynamics of Trade
Product Life Cycle (PLC) Theory
The optimal location for the production of certain types of goods
and services shifts over time as they pass through the stages
of market introduction, growth, maturity, and decline.
1.
Introduction: Innovation, production, and sales occur in the
domestic (innovating) country. Innovative customers tend to
accept relatively high introductory prices.
2.
Growth: As demand grows, competitors enter the market.
Foreign demand,competition,exports,and investment
activities also begin to accelerate.
3.
Maturity: Global demand begins to peak, production
processes are relatively standardized, and global price
competition forces production site relocation to lower-cost
developing countries.
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4. Decline: Market factors and cost pressures dictate
that almost all production occur in developing
countries.
Not all products conform to the dynamics of the Product
Life Cycle.
The Porter Diamond
National competitive advantage is embedded in four
determinants:
a)
Demand conditions
b)
Factor conditions
c)
Related and supporting industries
d)
Firm strategy, structure, and rivalry.
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Global Competitive Advantage
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Product Life Cycle Theory
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Introduction
Growth
Maturity
Decline
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Production Location
Market Location
Competitive Factors
Production Technology
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Limitations of Product Life Cycle
Theory
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Products with extremely short PLCs
Luxury products where cost may be
of little concern
Businesses with products that follow
a differentiation strategy
Products that require specialized
technical labor for subsequent
generations
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Looking to the Future
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Protectionist sentiment is growing
Economies are growing, therefore
efficiencies of multiple production
locations grow
Flexible, small-scale production
methods are on the rise
(robotics/automation processes)
Services are growing faster than
production in industrial countries
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Categories of World Trade
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Economically Linking Countries
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Chapter Review
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Explain trade theories
Discuss how global efficiency can be
increased through free trade
Introduce prescriptions for altering
trade patterns
Explore how business decisions
influence international trade
2004 Prentice Hall, Inc
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