5

International
Trade Theory
McGraw-Hill/Irwin
Global Business Today, 5e

2008 The McGraw-Hill Companies, Inc., All Rights

Reserved.

Chapter 5: International
Trade Theory
INTRODUCTION
In this chapter:
Theories that explain why it is beneficial for a country to
engage in international trade are presented
The patterns of international trade that is observed in the world
economy are explained

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Chapter 5: International
Trade Theory

AN OVERVIEW OF TRADE THEORY

Free trade refers to a situation where a government does not
attempt to influence through quotas or duties what its citizens can
buy from another country or what they can produce and sell to
another country.

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Chapter 5: International
Trade Theory

The Benefits of Trade

The Pattern of International Trade
Trade Theory and Government Policy

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Chapter 5: International
Trade Theory

MERCANTILISM
Mercantilism, which emerged in England in the mid-16th
century, asserted that it is in a countrys best interest to maintain
a trade surplus-- to export more than it imports.

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Chapter 5: International
Trade Theory
ABSOLUTE ADVANTAGE
In 1776, Adam Smith attacked the mercantilist assumption that
trade is a zero-sum game and argued that countries differ in their
ability to produce goods efficiently, and that a country has an
absolute advantage in the production of a product when it is
more efficient than any other country in producing it.
Zero Sum game

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Example
Country

Olive Oil

Shoes

Spain

Italy

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Chapter 5: International
Trade Theory
COMPARATIVE ADVANTAGE
In 1817, David Ricardo argued that it makes sense for a country
to specialize in the production of those goods that it produces
most efficiently and to buy the goods that it produces less
efficiently from other countries, even if this means buying goods
from other countries that it could produce more efficiently itself
Greatest Relative Advantage

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Example
Spain- 1unit of resource =1unit of oil or unit of shoes
Italy- 1 unit of resource=1/6 unit of oil or 1/3 unit of shoes
1/3 shoes by Italy= 1/3 Oil by spain, get Twice benefit
1unit of oil by Spain=1 unit of shoes
Country

Olive oil

Shoes

Spain

Italy

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Chapter 5: International
Trade Theory

The Gains from Trade

Qualifications and Assumptions
Extensions of the Ricardian Model

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Chapter 5: International
Trade Theory
HECKSCHER-OHLIN THEORY
Hecksher and Ohlin argued that that countries will export goods
that make intensive use of those factors that are locally abundant,
while importing goods that make intensive use of factors that are
locally scarce.
Leontif paradox
qqqq

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Chapter 5: International
Trade Theory
THE PRODUCT LIFE CYCLE THEORY
In the mid-1960s, Raymond Vernon proposed the product lifecycle theory that suggested that as products mature both the
location of sales and the optimal production location will change
affecting the flow and direction of trade.
Evaluating the Product Life Cycle Theory

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Chapter 5: International
Trade Theory

NEW TRADE THEORY

New trade theory suggests that because of economies of scale
(unit cost reductions associated with a large scale of output) and
increasing returns to specialization, in some industries there are
likely to be only a few profitable firms

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Chapter 5: International
Trade Theory

Increasing Product Variety and Reducing Costs

Economies of Scale, First Mover Advantages and the Pattern of
Trade
Implications of New Trade Theory

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Chapter 5: International
Trade Theory
NATIONAL COMPETITIVE ADVANTAGE: PORTERS
DIAMOND
Porters 1990 study tried to explain why a nation achieves
international success in a particular industry and identified
attributes that promote or impede the creation of competitive
advantage.

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Chapter 5: International
Trade Theory
Factor Endowments
Demand Conditions
Related and Supporting Industries
Firm Strategy, Structure, Rivalry
Evaluating Porters Theory

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Chapter 5: International
Trade Theory
FOCUS ON MANAGERIAL IMPLICATIONS
There are at least three main implications for international
businesses:
Location
First-Mover Advantages
Government Policy

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