International bussiness the challenge of global competition 11e chapter 03

chapter three
Theories of International Trade
and Investment

McGraw-Hill/Irwin
International Business, 11/e

Copyright © 2008 The McGraw-Hill Companies, Inc. All rights reserved.


Learning Objectives

 Explain the theories that attempt to explain

why certain goods are traded internationally

 Discuss the arguments for imposing trade
restrictions

 Explain two basic kinds of import restrictions:
tariff and nontariff trade barriers

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Learning Objectives

 Appreciate the relevance of changing status of
tariff and nontariff barriers to managers

 Explain some of the theories of foreign direct
investment

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International Trade Theory
• Mercantilism
– Economic philosophy based on belief that
• (1) a nation’s wealth depends on accumulated
treasure, usually gold, and
• (2) to increase wealth, government policies
should promote exports and discourage imports

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Theory of Absolute Advantage
• Absolute advantage
– Theory that a nation has absolute
advantage when it can produce a larger
amount of a good or service for the same
amount of inputs as can another country or
– When it can produce the same amount of a
good or service using fewer inputs than
could another country

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Absolute Advantage
Example

Each Country Specializes

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Absolute Advantage
Terms of Trade (Ratio of International Prices)

Gains from Specialization and Trade

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Theory of Comparative Advantage
• Comparative Advantage
– A nation having absolute disadvantages in
the production of two goods with respect to
another nation has a comparative or relative
advantage in the production of the good in
which its absolute disadvantage is less

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Theory of Comparative Advantage
Example

Each Country Specializes

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Comparative Advantage
Terms of Trade – at a rate of ¾ bolt of cloth for 1 ton of soybeans

Terms of Trade – at a rate of 1 bolt of cloth for 1 ton of soybeans

Gains from Specialization and Trade

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Comparative Advantage
• Production Possibility Frontiers (figure 3.1)
Figure
3.1

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Heckscher-Ohlin Theory of Factor
Endowment
• Factor Endowment
– Heckscher-Ohlin theory that countries
export products requiring large amounts of
their abundant production factors and import
products requiring large amounts of their

scarce production factors

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Heckscher-Ohlin Theory of Factor
Endowment
• Leontief Paradox
– The United States, one of the most capital-intensive
countries in the world, was exporting relatively
labor-intensive products in exchange for relatively
capital-intensive products

• Differences in Taste
– A demand-side construct that is always difficult to
deal with in economic theory

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How Can Money Change The
Direction of Trade?
Example

Exchange Rate – the price of one currency stated in terms of another currency

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How Can Money Change The

Direction of Trade?
• Influences of Exchange Rate
– Currency devaluation
• The lowering of a currency’s price in terms of
other currencies

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Some Newer Explanations For The
Direction Of Trade
• Linder Theory of Overlapping Demand
– Customers’ tastes are strongly affected by
income levels; therefore a nation’s income
per capita level determines the kinds of
goods they will demand

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Some Newer Explanations For The
Direction Of Trade
• International Product Life Cycle (IPLC)
– Explains why a product that begins as
export eventually becomes import (figure
3.2)
•
•
•
•

U.S. exports
Foreign production begins
Foreign competition in export market
Import competition in the United States

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Figure 3.2 International Product Life
Cycle

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Some Newer Explanations For The
Direction Of Trade
• Technology Life Cycle
– Production technology application of IPLC

• Economies of Scale and Experience Curve
– As a plant gets larger and output increase, the
average cost of producing each unit of output
decreases
– As firms produce more products, they learn ways to
improve production efficiency

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Some Newer Explanations For The
Direction Of Trade
• Imperfect Competition
– Economies of scale with the existence of
differentiated products--Paul Krugman
• First-Mover Theory
– Pattern of trade in goods subject to scale
economies may be determined by historical
factors

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Some Newer Explanations For The
Direction Of Trade
• National Competitive Advantage from Regional
Clusters: Porter’s Diamond Model (figure 3.3)
– National Competitiveness: a nation’s relative ability
to design, produce, distribute, or service products
while earning increasing returns on resources
• Demand conditions
• Factor Conditions
• Related and supporting industries
• Firm strategy, structure, and rivalry

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Figure 3.3 Variable Impacting Competitive
Advantage: Porter’s Diamond

Source: Reprinted by permission of the Harvard Business Review. “The Competitive Advantage of Nations” by Michael E. Porter,
March–April 1990, p. 77. Copyright © 1990 by The President and Fellows of Harvard College; all rights reserved.

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Trade Restrictions: Arguments For
•
•
•
•

National Defense
Sanctions to Punish Offending Nations
Protect Infant (or Dying) Industry
Protect Domestic Jobs from Cheap Foreign
Labor
• Scientific Tariff or Fair Competition

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Trade Restrictions
• Retaliation
– Dumping: selling a product abroad for less
than the cost of production, the price in the
home market, or the price to third countries
•
•

•
•
•

Social dumping
Environmental dumping
Financial services dumping
Cultural dumping
Tax dumping

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