Chapter Six International Trade Theory 2004 Prentice Hall

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Chapter Six International Trade Theory 2004 Prentice Hall, Inc 5 -1 International Business 10

Chapter Six International Trade Theory 2004 Prentice Hall, Inc 5 -1 International Business 10 e Daniels/Radebaugh/Sullivan International Business

Chapter Objectives n n Explain trade theories Discuss how global efficiency can be increased

Chapter Objectives n n 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 5 -2

General Types of Trade Theories n Descriptive: the natural order of trade • Tolerant

General Types of Trade Theories n Descriptive: the natural order of trade • Tolerant conditions • Which products, how much, and with whom a country will trade in the absence of restrictions n Prescriptive: questions whether governments should interfere with the free movement of goods and services 2004 Prentice Hall, Inc 5 -3

Mercantilism n n Initial trade theory that formed the foundation of economic thought from

Mercantilism n n 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” 2004 Prentice Hall, Inc 5 -4

Mercantilism Terms n n n Favorable balance of trade: country is exporting more than

Mercantilism Terms n n n 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 2004 Prentice Hall, Inc 5 -5

Absolute Advantage n n Absolute advantage holds that different countries produce some goods more

Absolute Advantage n n Absolute advantage holds that different countries produce some goods more efficiently than other countries Thus, global efficiency can be increased through international free trade 2004 Prentice Hall, Inc 5 -6

Country Specialization n Under the concept of absolute advantage countries could increase efficiency because:

Country Specialization n Under the concept of absolute advantage countries could increase efficiency because: Labor could become more skilled by repeating the same tasks n Labor would not lose time in switching from the production of one kind of product to another n Long production runs would provide incentives for the development of more effective working methods n 2004 Prentice Hall, Inc 5 -7

Natural Advantage n Countries have inherent advantages • Climate • Natural resources • Labor

Natural Advantage n Countries have inherent advantages • Climate • Natural resources • Labor forces n Two countries that have opposite natural advantages should favor trade with one another 2004 Prentice Hall, Inc 5 -8

Acquired Advantage n n n Most contemporary trade is manufactured goods and services rather

Acquired Advantage n n n 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 2004 Prentice Hall, Inc 5 -9

Absolute Trade Advantage 2004 Prentice Hall, Inc Figure 5. 2 5 -10

Absolute Trade Advantage 2004 Prentice Hall, Inc Figure 5. 2 5 -10

Comparative Advantage n n n There are still global gains to be made if

Comparative Advantage n n n 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. n Analogous Explanation n Production Possibility example 2004 Prentice Hall, Inc 5 -11

Comparative Advantage Figure 5. 3 2004 Prentice Hall, Inc 5 -12

Comparative Advantage Figure 5. 3 2004 Prentice Hall, Inc 5 -12

Basic Assumptions and Limitations of the Theories of Specialization n n n n Full

Basic Assumptions and Limitations of the Theories of Specialization n n n n 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 2004 Prentice Hall, Inc 5 -13

Factor Proportions The composition of a country’s trade depends on both its natural and

Factor Proportions The composition of a country’s trade depends on both its natural and acquired advantages. Acquired advantage “Factor-Proportions Theory”: n Differences in a country’s relative endowments of land, labor, and capital explain differences in the cost of production factors. n A country will tend to export products that utilize relatively abundant factors of production because they are relatively cheaper than scarce resources. 2004 Prentice Hall, Inc 5 -14

Production Technology When the same product can be produced by different methods, choosing the

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

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. 2004 Prentice Hall, Inc

Country-Similarity Theory When a firm develops a new product in response to observed conditions

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. 2004 Prentice Hall, Inc

The Dynamics of Trade Product Life Cycle (PLC) Theory The optimal location for the

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. 2004 Prentice Hall, Inc

4. Decline: Market factors and cost pressures dictate that almost all production occur in

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. 2004 Prentice Hall, Inc

Global Competitive Advantage 2004 Prentice Hall, Inc 5 -15

Global Competitive Advantage 2004 Prentice Hall, Inc 5 -15

Product Life Cycle Theory n n Introduction Growth Maturity Decline 2004 Prentice Hall, Inc

Product Life Cycle Theory n n Introduction Growth Maturity Decline 2004 Prentice Hall, Inc Production Location Market Location Competitive Factors Production Technology 5 -16

Limitations of Product Life Cycle Theory n n Products with extremely short PLCs Luxury

Limitations of Product Life Cycle Theory n n 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 2004 Prentice Hall, Inc 5 -17

Looking to the Future n n Protectionist sentiment is growing Economies are growing, therefore

Looking to the Future n n 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 2004 Prentice Hall, Inc 5 -18

Categories of World Trade 2004 Prentice Hall, Inc 5 -19

Categories of World Trade 2004 Prentice Hall, Inc 5 -19

Economically Linking Countries 2004 Prentice Hall, Inc 5 -20

Economically Linking Countries 2004 Prentice Hall, Inc 5 -20

Chapter Review n n Explain trade theories Discuss how global efficiency can be increased

Chapter Review n n 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 5 -21