IB_chapter3_International trade theory and political reality

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Product life cycle theory
Fig 3.3
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New trade theory
In industries with high fixed costs: Specialization increases output, and the ability to enhance economies of scale increases learning effects are high. These are cost savings that come from “learning by doing”
International Business
Chapter 3 International Trade Theory and Political Reality
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Case- The hollowing out of the U.S. based economy
Economic assumption: free trade produces gains for all participating countries Recently, US economy indicate a movement of knowledge based jobs to developing economies. Economists believe that:
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Theory of absolute advantage
Adam Smith: Wealth of Nations (1776) argued: Capability of one country to produce more of a product with the same amount of input than another country can vary A country should produce only goods where it is most efficient, and trade for those goods where it is not efficient Trade between countries is, therefore, beneficial Assumes there is an absolute balance among nations
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Theory of national competitive advantage
The theory attempts to analyze the reasons for a nations success in a particular industry Porter studied 100 industries in 10 nations
Makes better use of resources Trade is a positive-sum game
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Theory of comparative advantage
Assume that: Ghana and South Korea both have 200 units of resources, these can be used to produce either rice and cocoa. It takes 10 resources to produce 1 ton of cocoa and 13.333 resources to produce 1 ton of rice in Ghana. It takes 40 resources to produce 1 ton of cocoa and 20 resources to produce 1 ton of rice in South Korea. No trade: Each country uses half of its resources to product rice and half to product cocoa. Trade: Ghana product at point C, South Korea product at point K’.
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New trade theory-applications
Typically, requires industries with high, fixed costs
World demand will support few competitors
Competitors may emerge because of “ Firstmover advantage”
1. 2. 3. 4. 5.
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Theory of absolute advantage
Fig 3.1 production possibility frontier (PPF) Ghana South Korea
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Absolute advantage and the gains from trade
Increased exports leads to inflation and higher prices Increased imports lead to lower prices
Result: Country A sells less because of high prices and Country B sells more because of lower prices In the long run, no one can keep a trade surplus
only routine skill jobs go overseas. Most managerial and , marketing and R&D jobs retained in the country. Lower price of services means consumer can consume more for less Economic growth overseas will benefit the U.S.
Export goods that intensively use factor endowments which are locally abundant Import goods made from locally scarce factors
Note: Factor endowments can be impacted by government policy - minimum wage
Patterns of trade are determined by differences in factor endowments - not productivity Remember, focus on relative advantage, not absolute advantage
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Economies of scale may preclude new entrants Role of the government becomes significant
Some argue that it generates government intervention and strategic trade policy
Example: Ghana/cocoa South Korea/rice
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Theory of absolute advantage
Assume that: Ghana and South Korea both have 200 units of resources, these can be used to produce either rice and cocoa. It takes 10 resources to produce 1 ton of cocoa and 20 resources to produce 1 ton of rice in Ghana. It takes 40 resources to produce 1 ton of cocoa and 10 resources to produce 1 ton of rice in South Korea. No trade: Each country uses half of its resources to product rice and half to product cocoa. Trade: Ghana product at point G, South Korea product at point K’.
postulated determinants of competitive advantage of a nation were based on four major attributes
Factor endowments Demand conditions Related and supporting industries Firm strategy, structure and rivalry
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Porter’s diamond
Success occurs where these attributes exist. More/greater the attribute, the higher chance of success The diamond is mutually reinforcing
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Mercantilism: mid-16th century
A nation’s wealth depends on accumulated treasure
Gold and silver are the currency of trade
Theory says you should have a trade surplus.