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Part 2:
INTERNATIONAL TRADE
THEORY

Lecturer: Tran Quoc Trung (MBA)

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Contents

1 Classical Trade Theories

Ø Mercantilism (Pre-16th century)

Ø Absolute Advantage (A. Smith, 1776)
Ø Comparative Advantage (D. Ricardo, 1817)
2 Neo-classical Trade Theories

Ø Factor-Endowment (Heckscher - Ohlin, 1919)

3 New Trade Theories

Ø Economies of Scale & Int’l Trade (P. Krugman, 1980s)

Ø International Product Life Cycle (R. Vernon, 1966)
Ø National Competitive Advantage (M. Porter, 1990)
Lecturer: Tran Quoc Trung (MBA)

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1. Classical Trade Theories

1.1. Mercantilism
v Popular from 1500 - 1800 in Europe.
v Europe was experiencing an acute
shortage of gold and silver bullion for use as
money in domestic and international
transactions.
v Mercantilism developed at a time when
the European economy was in transition
(Feudalism to capitalism).
Lecturer: Tran Quoc Trung (MBA)

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1.1. Mercantilism

1.1.1. Main Views on Trade

v A nation’s wealth means holdings of
precious metals.
v A country should strive to achieve a
favorable balance of trade.
v The government intervention was necessary
to maximize national advantages in trade.
v Trade is a zero-sum game.
Lecturer: Tran Quoc Trung (MBA)

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1.1. Mercantilism

“The Exportation of our Monies in

Trade of Merchandize is a means to
encrease our Treasure”.
“England's Treasure by Forraign Trade”, Chap. IV

Thomas Mun
Lecturer: Tran Quoc Trung (MBA)

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1.1. Mercantilism

1.1.4. Comments
v Advantages
§ Advocating international trade.
§ Recognizing the role of governments in
controlling and regulating international
trade.
v Disadvantages
§ Money is wealth. The world’s wealth is fixed.
§ Trade is a zero-sum game.
Lecturer: Tran Quoc Trung (MBA)

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1. Classical Trade Theories

1.2. Absolute Advantage Theory

A Scottish social philosopher and

a pioneer of political economy.
- 1737: Studying at Glasgow University.
After graduating, Smith delivered a
successful series of public lectures at
Edinburgh, leading him to collaborate
with David Hume during the Scottish
Enlightenment.
- 1766: Smith then returned home and
Adam Smith
spent the next ten years writing The
(1723 – 1790)
Wealth of Nations, publishing it in 1776.
Lecturer: Tran Quoc Trung (MBA)

1.2. Absolute Advantage Theory LOGO

1.2.1. The wealth of nations

v The wealth depends on productive capacity.
v The world’s wealth is not a fixed quantity.
1.2.2. Labor theory of value
v Labor is the only factor of production and is
homogeneous.
v The cost or price of a good depends exclusively
on the amount of labor required to produce it.
v Cost differences govern the international trade.

Lecturer: Tran Quoc Trung (MBA)

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1.2. Absolute Advantage Theory

1.2.3. Principle of Absolute Advantage

v In a two-nation, two-product world,
international specialization and trade will be
beneficial when one nation has an absolute
cost advantage in one good and the other
nation has an absolute cost advantage in the
other good.
v Absolute cost advantage means using
less labor to produce a unit of output.
Lecturer: Tran Quoc Trung (MBA)

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1.2. Absolute Advantage Theory

1.2.4. Illustration of The Model

In autarky (Without trade), Vietnam and
India can produce the following outputs
with 01 labor unit.

Rice (tons) Material (m2)

Vietnam 10 6
>
>

India 5 10
Lecturer: Tran Quoc Trung (MBA)

1.2. Absolute Advantage Theory LOGO

1.2.4. Illustration of The Model

Specialization and trade in goods with
absolute advantage.
Rice (tons) Material (m2)
Vietnam +10 -6

India -5 +10
Total +5 +4

Lecturer: Tran Quoc Trung (MBA)

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1.2. Absolute Advantage Theory

1.2.5. Sources of Absolute Advantage

v Natural advantages
Climate, soil, and mineral wealth.
Ex: Vietnamese rice, Brazilian coffee…
v Acquired advantages
Special skills and techniques.
Ex: Swiss watches, Danish silver plates…

Lecturer: Tran Quoc Trung (MBA)

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1. Classical Trade Theories

1.3. Comparative Advantage Theory

- Born in England, Ricardo was the

third of 17 children of a Jewish family.
His father was a successful stockbroker.
- He was also a member of Parliament,
businessman, financier and speculator,
who amassed a considerable personal
fortune.
- Ricardo's most famous work is his
David Ricardo “Principles of Political Economy and
(1772-1823) Taxation” (1817).
Lecturer: Tran Quoc Trung (MBA)

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1.3. Comparative Advantage Theory

1.3.1. Assumptions
v The world consists of two nations, each using
a single input to produce two commodities.
v In each nation, labor is the only input.
v Labor can move freely among industries
within a nation but is incapable of moving
between nations.
v The level of technology is fixed.
v Costs don’t vary with the level of production
& are proportional to the amount of labor used.
Lecturer: Tran Quoc Trung (MBA)

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1.3. Comparative Advantage Theory

1.3.2. The Law of Comparative Advantage

The less efficient nation should specialize in
and export the good in which it is relatively
less inefficient (where its absolute
disadvantage is least). The more efficient
nation should specialize in and export that
good in which it is relatively more efficient
(where its absolute advantage is greatest).
Lecturer: Tran Quoc Trung (MBA)

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1.3. Comparative Advantage Theory

1.3.3. Illustration of The Model

In autarky, labor costs needed to produce 1 kg of
wheat OR 1 litter of wine in Britain and Portugal as
follows:

In Britain In Portugal
(labor hour) (labor hour)

1 kg of wheat 15 10

1 litter of wine 30 15

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1.3. Comparative Advantage Theory

1.3.5. Comments
v Advantages
Development of the absolute advantage ,
and absolute advantage can be view as the
special situation of comparative advantage .
v Disadvantages
Ricardian trade theory relied solely on
supply analysis, it was not able to determine
actual terms of trade.
Lecturer: Tran Quoc Trung (MBA)

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1.3. Comparative Advantage Theory

1.3.6. What Are Terms of Trade?

Terms of trade are the rate at which
one country’s export product is traded for
the other country’s export product. The
terms of trade define the relative prices at
which two products trade in the
marketplace.

Lecturer: Tran Quoc Trung (MBA)

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1.3. Comparative Advantage Theory

1.3.7. Theory of reciprocal demand

Within the outer limits of the terms of

trade, the actual terms of trade are
determined by the relative strength of
each country’s demand for the other
country’s product.

J. Stuart Mill
Lecturer: Tran Quoc Trung (MBA)

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1.3. Comparative Advantage Theory

1.3.8. Revealed Comparative Advantage

EXA: Country A’s exports of commodity X

EA: Country A’s total exports
EXW: The World’s exports of commodity X
EW: The World’s total exports
q RCA ³ 1: A has a comparative advantage in X
q RCA < 1: A has a comparative disadvantage in X
Lecturer: Tran Quoc Trung (MBA)

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Contents

1 Classical Trade Theories

Ø Mercantilism (Pre-16th century)

Ø Absolute Advantage (A. Smith, 1776)
Ø Comparative Advantage (D. Ricardo, 1817)
2 Neo-classical Trade Theories

Ø Factor-Endowment (Heckscher - Ohlin, 1919)

3 New Trade Theories

Ø Economies of Scale & Int’l Trade (P. Krugman, 1980s)

Ø International Product Life Cycle (R. Vernon, 1966)
Ø National Competitive Advantage (M. Porter, 1990)
Lecturer: Tran Quoc Trung (MBA)

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2. The factor endowment theory LOGO

The factor endowment theory is

developed by E. Heckscher and B.
Ohlin at the Stockholm School of
Economics. It builds on the theory
of comparative advantage by
predicting patterns of commerce
Eli Heckscher Bertil G. Ohlin and production based on the factor
(1879 - 1952) (1899-1979) endowments of a trading region.
E. Heckscher was a Swedish political economist and economic
historian professor of at the Stockholm School of Economics .
B. Ohlin was not only a professor of economics, but also the
Minister of Trade during World War II. In 1979 Ohlin was
awarded a Nobel prize for his work in international trade theory.
Lecturer: Tran Quoc Trung (MBA)

2. The factor endowment theory LOGO

2.1. Assumptions
v Two nations, two commodities (X and Y) and
two factors (labor and capital);
v The same production technology;
v Constant returns to scale;
v Incomplete specialization in production;
v Tastes are equal;
v Perfect competition;
v Perfect factor mobility within each nation but
no international factor mobility;
v No transportation costs, tariffs.
Lecturer: Tran Quoc Trung (MBA)

2. The factor endowment theory LOGO

Heckscher - Ohlin

Main
theorems of Factor-price equalization
the factor
endowment
Rybczynski
theory

Stolper - Samuelson
Lecturer: Tran Quoc Trung (MBA)

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2. The factor endowment theory LOGO

2.2. Heckscher – Ohlin Theorem

A nation will export the commodity whose
production requires the intensive use of the
nation’s relatively abundant factor and import
the commodity whose production requires the
intensive use of the nation’s relatively scarce factor.

In particular, a capital-abundant country will export

the capital-intensive good while the labor-abundant
country will export the labor-intensive good.
Lecturer: Tran Quoc Trung (MBA)

2. The factor endowment theory LOGO

2.2. Heckscher – Ohlin Theorem

v Factor intensity

v Factor abundance

Lecturer: Tran Quoc Trung (MBA)

2. The factor endowment theory LOGO

2.3. Factor-price equalization

When the prices of the output goods are
equalized between countries, as when countries
move to free trade, then the prices of the factors
will also be equalized between countries.

Lecturer: Tran Quoc Trung (MBA)

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2. The factor endowment theory LOGO

2.4. Rybczinski Theorem

At constant relative goods prices, a rise in
the endowment of one factor will lead to a
more than proportional expansion of the
output in the sector which uses that factor
intensively, and an absolute decline of the
output of the other good.

Lecturer: Tran Quoc Trung (MBA)

2. The factor endowment theory LOGO

2.5. Stolper – Samuelson Theorem

A rise in the relative price of a good will
lead to a rise in the return to that factor
which is used most intensively in the
production of the good, and conversely, to a
fall in the return to the other factor.

Lecturer: Tran Quoc Trung (MBA)

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Contents

1 Classical Trade Theories

Ø Mercantilism (Pre-16th century)

Ø Absolute Advantage (A. Smith, 1776)
Ø Comparative Advantage (D. Ricardo, 1817)
2 Neo-classical Trade Theories

Ø Factor-Endowment (Heckscher - Ohlin, 1919)

3 New Trade Theories

Ø Economies of Scale & Int’l Trade (P. Krugman, 1980s)

Ø International Product Life Cycle (R. Vernon, 1966)
Ø National Competitive Advantage (M. Porter, 1990)
Lecturer: Tran Quoc Trung (MBA)

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3. New Trade Theories

3.1. Economies of Scale & Int’l Trade

Paul Robin Krugman is a professor at
Princeton Universityand and an columnist for
The New York Times.
Krugman was awarded the Nobel Memorial
Prize in Economic Sciences in 2008 for his
work associated with New Trade Theory and
P. R. Krugman the New Economic Geography.

Ø Why do Europe and the United States trade in such a

great volume?
Ø Why do Germany and Japan will trade automobiles with
each other?
Lecturer: Tran Quoc Trung (MBA)

3.1. Economies of Scale & Int’l Trade LOGO

3.1.1. Concepts
Economies of Scale refers to the Increasing
Returns to Scale which means the production
situation where output grows proportionately
more than the increase in inputs.
Cars

PPF

O Lecturer: Tran Quoc Trung (MBA) Airplanes

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3.1. Economies of Scale & Int’l Trade

3.1.1. Concepts
v Internal economies of scale occur
when the cost per unit depends on the size
of an individual firm but not necessarily on
that of the industry.

Lecturer: Tran Quoc Trung (MBA)

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3.1. Economies of Scale & Int’l Trade

3.1.1. Concepts
v External economies of scale occur
when the cost per unit depends on the size
of the industry but not necessarily on the
size of any one firm.

Lecturer: Tran Quoc Trung (MBA)

3.1. Economies of Scale & Int’l Trade LOGO

Cars Japan

N
I3
I2
S I1 EH
EN

E
PPF The U.S.
O Airplanes
T H
Lecturer: Tran Quoc Trung (MBA)

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3.2. International Product Life Cycle

3.2.1. The imitation lag hypothesis

It was introduced in 1961 by Michael V. Posner &
paved the way for the product cycle theory.

Learning period
Reaction lag
Export Advantage
Demand lag

Imitation lag
Lecturer: Tran Quoc Trung (MBA)
Time

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3.2. International Product Life Cycle

3.2.1. The Product Cycle Theory

Exports
I II III

Inventing country Developed country Least developed country

t3
t0
t1 t2 t4
Time

New product stage Maturing product stage Standardized product stage

Imports Lecturer: Tran Quoc Trung (MBA)

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3.3. National Competitive Advantage

Porter’s Diamond

Government Related and

supporting industries

Factor Demand
endowments conditions

Firm strategy,
structure & rivalry Chance
Lecturer: Tran Quoc Trung (MBA)

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3.3. National Competitive Advantage

3.3.1. Factor Endowments

v These factors can be either basic (natural
resources, climate, location) or advanced
(skilled labor, infrastructure, technological
know-how).
v Basic factors can provide an initial
advantage that is then reinforced and
extended by investment in advanced
factors.
Lecturer: Tran Quoc Trung (MBA)

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3.3. National Competitive Advantage

3.3.2. Demand conditions

v Demand conditions refers to the nature of
home demand for an industry’s product or
service.
v Demand conditions influence the
development of capabilities.
v Sophisticated and demanding customers
pressure firms to be more competitive and to
produce high quality, innovative products.
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3.3. National Competitive Advantage

3.3.3. Related and supporting industries

v Related and supporting industries refers
to the presence supplier industries and
related industries.
v Investing in these industries can spill over
and contribute to success in other industries.
Ex: Having world class manufacturers of semi-
conductor processing equipment can lead to
(and be a result of having) a competitive semi-
conductor industry.
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3.3. National Competitive Advantage

3.3.4. Firm strategy, structure, and rivalry

v It is the conditions in the nation governing
how companies are created, organized, and
managed the domestic rivalry.
v Different nations are characterized by
different management ideologies.
v There is a strong association between
vigorous domestic rivalry and the creation and
persistence of competitive advantage in an
industry.
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Lecturer: Tran Quoc Trung (MBA)

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