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Introduction to International Trade

Imports are the goods and services that we buy from people in other countries.
Exports are the goods and services we sell to people in other countries.
International Trade Restrictions
Governments restrict international trade to protect domestic producers from
competition by using three main tools:
1. A tariff is a tax that is imposed by the importing country when an imported good
crosses its international boundary.
2. A subsidy is a payment made by a government to a domestic producer based on
the quantity produced
3. A quota is a limit on the quantity of a good that may be imported
4. Today we will explore tariffs and quotas

How subsidies work

1. A subsidy works just like a tax, but in the opposite direction.
2. A subsidy shifts the supply curve rightward, lowers the price, increase the quantity,
and creates a deadweight loss from overproduction
3. If a subsidy is granted on an export or an import it changes the amount of
international trade
Impact of Tariffs (cont.)
Consumption loss
a measure of the benefit lost to consumers that is not captured by other elements in
Production loss
the value of production lost to society
Deadweight loss
the reduction in the total level of welfare (or real incomes) across society due to tariff
Effects on foreign producers
income of foreign producers will fall
Government revenue
1. the government gains by obtaining tariff revenue
2. tariff revenue is essentially a transfer of income from consumers to government
and does not represent any net change in the nations economic wellbeing
Production and Consumption Possibilities and the Benefits of Trade
Closed Economy
An economy that does not trade with the rest of the world
Open Economy
An economy that trades with other countries
A Supply and Demand Perspective on Trade
1. If the price of a good or service in a closed economy is greater than the world price,
and that economy opens itself to trade, the economy will tend to become a net
importer of that good or service.
2. If the price of a good or service in a closed economy is lower than the world price,
and that economy opens itself for trade, the economy will tend to become a net
exporter of that good or service

The view that free trade is injurious and should be restricted
A tax imposed on an imported good
A legal limit on the quantity of a good that may be imported
Why would the government ever impose a quota rather than a tariff?
1. tariffs are revenues
2. quotas more likely encourage smuggling
3. quotas encourage corruption

The Inefficiency of Protectionism

1. Trade barriers are inefficient and reduce the size of the economic pie.
2. Because trade barriers benefit certain groups, and these groups may be well
organized, they may be successful in lobbying for trade barriers.
3. The gains from trade could be used to assist groups that have been hurt by trade
Trade Surpluses and Deficits
1. When a country exports more than it imports, it runs a trade surplus.
2. A trade deficit is the situation when a country imports more than it
Absolute Advantage versus Comparative Advantage
1. A country enjoys an absolute advantage over another country in the
production of a product when it uses fewer resources to produce that
product than the other country does.
2. A country enjoys a comparative advantage in the production of a good
when that good can be produced at a lower cost in terms of other goods.
Terms of Trade
1. The ratio at which a country can trade domestic products for imported
products is the terms of trade.
2. The terms of trade determine how the gains from trade are distributed
among trading partners.
Exchange Rates
1. An exchange rate is the ratio at which two currencies are traded, or the
price of one currency in terms of another.
2. For any pair of countries, there is a range of exchange rates that can
lead automatically to both countries realizing the gains from
specialization and comparative advantage.
The Sources of Comparative Advantage
Factor endowments refer to the quantity and quality of labor, land, and
natural resources of a country.
Factor endowments seem to explain a significant portion of actual world
trade patterns.
Other Explanations for Observed Trade Flows
1. Economies of scale may be available when producing for a world
market that would not be available when producing for a limited domestic
2. Export subsidies are government payments made to domestic firms to
encourage exports.
3. Dumping refers to a firm or industry that sells products on the world
market at prices below the cost of production.
Why studying International Business is Important

1. It is important because it allows the ability to act in business from our country to
other countries, using international treaties, exchange agreements and economic
agreements that facilitate trade and acquire a globalized vision of the international
economy and business Only from the commercial knowledge but also from the
logistic and customs knowledge, thus being able to understand the world market
and proceed to do business based on their own country.

2. It helps us to know how to carry out international market assessments and to

prepare an export or import plan to introduce our product and the company it
represents in that market. In other words, it seeks to generate new business
opportunities in a globalized world.

Factors Contributing to Rapid Growth of International Business

1. Increase in and expansion of technology
2. Liberalization of cross-border trade and resourcemovements
3. Development of services that support international business
4. Growing consumer pressures
5. Increased global competition
6. Changing political situations
7. Expanded cross-national cooperation
Companies Engage in International Business
1. To Expand Sales: pursuing international sales increases the potential market and
potential profits
2. To Acquire Resources: may give companies lower costs, new and better
products, additional operating knowledge
3. To Diversify or Reduce Risks: international operations may reduce operating risk
by smoothing sales and profits, preventing competitors from gaining advantage
Theory of Absolute Advantage
Adam Smith: Wealth of Nations (1776).
Capability of one country to produce more of a product with the
same amount of input than another country.
Produce only goods where you are most efficient, trade for
those where you are not efficient.
Assumes there is an absolute advantage balance among
Theory of Comparative Advantage
David Ricardo: Principles of Political Economy (1817).
1.Extends free trade argument
2.Efficiency of resource utilization leads to more productivity.
3.Should import even if country is more efficient in the products
production than country from which it is buying.
Makes better use of resources
Trade is a positive-sum game.
Heckscher (1919)-Olin (1933) Theory
Export goods that intensively use factor endowments which are
locally abundant.
Patterns of trade are determined by differences in factor
endowments - not productivity.
Remember, focus on relative advantage, not absolute
The New Trade Theory
Began to be recognized in the 1970s.
Deals with the returns on specialization where substantial
economies of scale are present.
Specialization increases output, ability to enhance economies of
scale increase.
What Is Globalization?
Globalization is a process of closer integration and exchange between different
countries and peoples worldwide.
Made possible by:
1. Falling trade and investment barriers
2. Advanced telecommunications
3. Reduced transportation costs
4. Importance of MNEs and FDIs
Multinational Enterprise (MNE)
Deploys resources and capabilities in the procurement, production, and distribution
in at least two countries
Less than 1% of firms, BUT employ 19% of U.S. workforce
74% of private sector R&D spending
Foreign Direct Investment (FDI)
Investments in value chain activities abroad
Global Strategy
To sustain a competitive advantage
Competing against foreign and domestic companies around the world
Why Global?
1Gain access to a larger market
Capitalize on market potential, such as China, India, and emerging economies
2Gain access to low-cost input factors
Labor, natural resources, technology, logistics
3Managing corporate risk
4Leverage core competencies
5Develop new competencies
Location economies
Unique locational advantages
Liability of foreignness
Additional cost of doing business in an unfamiliar cultural and economic
Cost of coordinating across geographic distance
Economic development may increase the cost of doing business
1.Rising wages with improved living standards
2.Difficulty in protecting intellectual property
Global Expansion: Where
How does an MNE decide where to go?
National institutions:
Well-established legal and ethical pillars as well as well- functioning economic
institutions such as capital markets, banks, and infrastructures
National culture: "Programming of the mind"
Power distance
Long-term orientation
Global Expansion: How
Exporting: producing goods in one country to sell in another country
Acquisition, strategic alliance are also popular vehicles for entry into foreign
MNEs sometime prefers greenfield operations or wholly-owned subsidiaries
Strategy around the World:Cost Reduction vs. Local Responsiveness
Local responsiveness:
Tailor product and service offerings to fit local consumer preferences and host-
country requirements
Higher cost
Example: McDonalds uses mutton in India
Cost reduction:
MNEs enter global marketplace withthe intention to reduce operation cost
Example: Toyota Prius
National Competitive Advantage Framework
Factor conditions
A nations endowments in terms of national, human, and other resources
as well as supportive infrastructure and institutions.
Demand conditions
Specific characteristics of demand in a firms domestic market
Competitive intensity
Highly competitive environments tend to stimulat firms to outperform
others (e.g., German car industry)
Related and supporting industry
Leadership in related and supporting industries can also foster world-
class competitors in downstream industry
Regional Clusters
Regional cluster
A group of interconnected companies and institutions in a specific
industry, located near each other geographically and linked by common
Knowledge spillover
Positive externalities that are regionally constrained
Exchange of ideas among firms in a cluster