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2022

Comparative Advantage
It is an add on theory to absolute theory.
It is brought to the world by David Ricardo.
Comparative better ness of producing a good by a country.
Example 1
Cheese Wine
UK 300 600
France 100 500

Accordingly, UK has absolute advantage over both products. UK

produces wine twice as cheese and France produces wine five times as
cheese.
UK is comparatively better at producing cheese and France is
comparatively better at producing wine.
So UK can produce 900kg of cheese and France can produce 600 liters
of wine.
Cheese Wine
UK 900 0
France 0 600
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Assumptions of Comparative Advantage.

 Costs stay the same – Two country Two goods theory. (2x2x2)
 Mobility of factors of production is 100% possible between
countries are possible.
 Absent Transportation expenses
 Absent of trade barriers to exit

Ad of Co Ad
1. Increased profits margin and decreased opportunity costs
2. A rise in efficiency.
Dis of Co Ad
1. Trade restrictions could be imposed by government
2. Comparative advantage may be outweighed by transportation
cost
3. Scaling difficulty.
4. Lot of assumptions that may be difficult to utilize.
5. Migration of raw materials or labors cannot be notified.
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Factor Endowment Theory

Bertil Ohlin was developed this theory on the basis of work by his
teacher Eli Filip Heckscher. Both were Swedish.

USA China

Capital labor

Capital intensive Labor intensive

good good

E.g. Machines E.g. Skilled Labors

According to this, countries to should look the availability of their

factors of production and then carefully select goods that can be
manufactured. It has to trade between countries.

Two into Two into

Two theory (2x2x2)
Country x
Commodities x
Assumptions of Factor Endowment Theory
Factors
1. Two country Two goods theory
2. Factors of production mobile between two industries within a
country but fop cannot move between countries.
3. Technology remain same.
4. Transportation cost ignored
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5. Trade barriers ignored.

Advantages
1. Availability of factors
Disadvantages
1. Two into Two theory

Modern International Trade Theories

Porter’s Five Forces
This identifies and analyzes 5 competitive forces that shape an industry
and he determine the industry’s strengths and weaknesses.
1. Competition in the industry
2. Threat of new entrants
3. Bargaining power of suppliers
4. Bargaining power of buyers
5. Availability of substitutes
Michael E. Porter was found the theory of Porter’s Five Forces. He also
found porter’s generic competitive strategy and porters diamond
model.
Threat of new entrants - If the set of entrants are high, it’s not good
and that will deteriorate your competitive advantage.
Bargaining power of suppliers - If the bargaining power is high, it’s not
good for your company and that will deteriorate your competitive
advantage.
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High bargaining power of suppliers - that will deteriorate your

competitive advantage.

Q. Analyze Sri Lanka’s tea industry and its competitiveness according to

its porter’s five force’s theory and suggest the way forward.
1. Competition in the industry – There is a high competition in the
Tea industry in Sri Lanka. For example, Dilmah Tea, Mabroc Tea,
Heritage Tea, Empire Tea and so on. These brands do exports to
many countries which tends to set competitive prices to attract its
customers in local and in foreign countries. Meanwhile there are
also local brands that are made cheaper to make affordable for
local customers.
2. Threat of New Entrants – There are high threats for new entrants
as there are less restrictions to start business in the tea industry
or for any foreign companies coming into Sri Lanka. Because Sri
Lanka has high resources to produce tea, companies might prefer
to utilize that and earn high profits.
3. Bargaining power of suppliers – There are high suppliers of
fertilizer, chemicals, packaging materials and labor. Where except
for labors, others put pressure to reduce prices. Where labors
have unions and may put pressure to increase wage rates. So the
companies have to manage all suppliers in order to produce
products profitably.
4. Bargaining power of buyers – In Sri Lanka's tea industry, there are
powerful buyers. Various companies and countries all over the
world buy tea from Sri Lanka because it is of good quality and
tastes better. Unilever is a major company that purchases a large
volume of tea from Sri Lanka.  Since there is lack of differentiation
in tea, buyers can easily switch to different buyer at no cost.
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However, because Sri Lanka exports a large volume of tea, it has

an excellent value for tea, which might set higher prices.
5. Availability of substitutes – There are also many substitute
products in Sri Lanka, with some made locally and others
imported. Soft drinks, juices, coffee, and alcohol are the most
commonly consumed beverages in Sri Lanka. This also has
an impact on the tea industry's profitability. However, most Sri
Lankans would buy tea at any cost since they have become
addicted to it and prefer, compared to coffee.

Porter splits the four crucial factors that weigh in as an inter-connected

‘diamond’.

The role of Government in the model