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THEORIES OF INTERNATIONAL TRADE

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Learning Objectives

To discuss the implications of trade theories on international business To explain various theories of international trade To examine gains from trade under various trade theories To explain the theoretical framework for shifting patterns of production and trade

Copyright @ Oxford University Press International Business R. M. Joshi

Implications of Trade Theories

Trade theories provides the conceptual base for international trade and shifts in trade patterns. They also facilitate in understanding the basic reasons behind the evolution of a country as a supply base or market for specific products.

Copyright @ Oxford University Press International Business R. M. Joshi

Theory of Mercantilism
The theory attributes and measures the wealth of a nation by the size of its accumulated treasures. It aims at accumulating financial wealth in terms of gold by encouraging exports and discouraging imports.

Copyright @ Oxford University Press International Business R. M. Joshi

Theory of Absolute Advantage

Absolute advantage may be defined as ability of a nation to produce the

goods more efficiently and cost effectively than any other country.

According to the theory, each country should specialize in producing

those goods that it can produce more efficiently, instead of producing

all products. Thus, a country should use increased production to export

and acquire more goods by way of imports which in turn would

improve living standards of its people.
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Absolute Advantage- Resources required to produce 1 ton of Cocoa and Rice

Ghana S.Korea With out trade

10 40

20 10

Ghana S.Korea With Specialization Ghana S.Korea After trade 6 tons

10 2.5 12.5 20 0 20 14 6

5 10 15 0 20 20 6 14

Increase in consumption 4 3.5

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1 4.0
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Theory of Comparative Advantage

Comparative Advantage may be defined as the inability of a nation to produce a good more efficiently than other nations, but its ability to produce that good more efficiently compared to the other good. Thus, the country may be at an absolute disadvantage with respect to both the

commodities but the absolute disadvantage is lower in one commodity than

another. Therefore, a country should specialize in the production and export of a commodity in which the absolute disadvantage is less than that of another commodity or in other words, the country has got a comparative advantage in terms of more production efficiency.Oxford University Press Copyright @
International Business
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R. M. Joshi

Comparative Advantage- Resources required to produce 1 ton of Cocoa and Rice

Ghana S.Korea With out trade

10 40

13.33 20

Ghana S.Korea With Specialization Ghana S.Korea After trade 4 tons

10 2.5 12.5 15 0 15 11 4

7.5 5 12.5 3.75 10 13.75 7.75 6

Increase in consumption 1 1.5

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.25 1.0
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Revealed Comparative Advantage

It is measured by a countrys share of world exports of a commodity divided by its share in total exports. RCAij = (Xij/Xwj)/(Xi / Xw) Where Xij = ith country export of commodity j Xw = world exports of commodity j Xi = total exports of country i Xw = total world exports
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Factor Endowment (Hecksher-Ohlin) Theory

Why comparative advantage- Factors of endowments land, labour, and capital. More abundant a factor , lower it costs. A nation will export the goods whose production requires intensive use of the nations

relatively abundant and cheap factors and import the goods whose production requires
intensive use of its scarce and expensive factors. US- Sustainable exporters of agricultural goods(Abundance of arable land) China- Exports goods from labor-intensive manufacturing units- footwear,textile
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The Leontief Paradox

Wassily Leontief carried out an empirical test of the Heckscher-Ohlin Model in 1951 and found that the US exported more labour-intensive commodities and

imported more capital intensive products which was

contrary to the results of Heckscher-Ohlin Model of

factor endowment.
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Country Similarity Theory

Trade occurs between nations that have similar characteristics, such as economic, geographic, cultural, etc. However, in case of manufactured goods, cost was determined by similarity in product demands across countries rather than by relative production costs or factor endowments
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The New Trade Theory

The theory elucidates that international trade enables a firm to increase its output due to specialization by providing larger markets, resulting into enhancing its efficiency. It helps explain the trade patterns when markets are not perfectly competitive or when economies of scale are achieved by production of specific products.
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International Product Life Cycle Theory

The theory explains the variations and reasons for change in production and consumption pattern among various

markets over a time period.

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Stages of International Product Life Cycle

The IPLC has four distinct identifiable stages that influences demand structure, production, marketing strategy, and international competition as follows:

Stage 1: Introduction Stage 2: Growth Stage 3: Maturity Stage 4: Decline

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Evaluating the product life cycle theory

Product developed- Xerox (1960) in US Sold initially to US users Exported- Japan and Western Europe As demand grew in these counties- Joint ventures- Japan( FujiXerox), Britain ( Rank-Xerox) After expiration of patent of Xerox- others countries started Like- Canon in Japan, Olivetti in Itlay US export declined US now purchase from lower cost foreign countries- Japan Facing high labor cost in Japan- Switched there operations to developing countries- Singapore, Thailand Hence- US and Japan- Exporters- Importers

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Theory of Competitive Advantage

According to the theory, a firms home country environment is the main source of competencies and innovations often referred to as the diamond mode, it focuses upon the four determinants: Factor (Input) Conditions

Firm Strategy and Rivalry

Demand Conditions Related and Supporting Industries

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