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MODERN THEORIES OF INTERNATIONAL TRADE 1. Resources and Trade (The Eli Heckscher and Bertil Ohlin Model) 2.

Specific Factors and Income Distribution (Paul Samuelson - Ronald Jones Model) 3. The Standard Model of Trade (Paul Krugman ± Maurice Obsfeld Model) 4. The Competitive Advantage (Michael Porter¶s Model) 1. Resources and Trade (The Eli Heckscher and Bertil Ohlin Model) The Heckscher-Ohlin theory explains why countries trade goods and services with each other, the emphasize being on the difference of resources between two countries. This model shows that the comparative advantage is actually influenced by the interaction between the resources countries have (relative abundance of production factors) and production technology (which influences the relative intensity by which the different production factors are being utilized during the production cycle. The model starts with the presumption that country A produces two products: food (X) and textiles (Y). These two kinds of production need two different inputs, territory (T) and labour (L), which are available in limited quantities. In the same time, food production (X) requires more land, so it can be said it is territory intensive and textile (Y) production requires more labour, being in this way labour intensive. Beginning with these presumptions, the Heckscher-Ohlin model explains the implications trade between two countries A and B has, if the countries produce the same products: food (X) and textiles (Y). The relative resource abundance, The relative abundance and trade factors Inputs and production without trade specialization in the product for intensity and which there is a factor intensity. trade specialization. Country Labour (L) Territory (T) L/T T/L A X Y X X 20 95 0.21 4.75 Y 10 5 2.00 0.50 Total 30 100 0.30 3.33 B X Y Y X 3 5 0.60 1.66 Y 10 2 5.00 1.20 Total 13 7 1.85 0.53 A country having a bigger offer in a resource than in another is relative abundant in that resource and tends to produce more products that use that resource. Countries are more efficient in producing goods for which they have a relative abundant resource. According to the Heckscher-Ohlin theory, trade makes it possible for each country to specialize. Each country exports the product the country is most suited to produce in exchange for products it is less suited to produce. In our case, country A is relative abundant in territory Product

elaborated a trade model based on specific factors. The Standard Model of Trade (Paul Krugman ± Maurice Obsfeld Model) The standard model of trade implies the existence of the relative global supply curve resulting from the production possibilities and the relative global demand curve resulting from the different preferences for a certain good. International trade also has an important effect on the distribution of incomes. When the two countries decide to trade. Specific Factors and Income Distribution (Paul Samuelson . the exchange rate improvement for a country implies a substantial rise in the welfare of that country. the relative global supply curve and the relative global demand curve. capital (K) and territory (T). If the other elements remain constant.Ronald Jones Model) There are at least two reasons why trade has an important influence upon the income distribution: a) resources can¶t be transferred immediately and without costs from one industry to another. The changes in relative prices of goods have a powerful effect on the relative income obtained from the different resources. while territory and capital are specific factors. 4. A country having capital abundance and less land tends to produce more manufactured products than food products. This is a tri-factorial model because it is based on 3 factors: labour (L).(T) and will specialize in producing food (X) and country B is relative abundant in labour (L) so it will specialize in producing textiles (Y). b) industries use different factors and a change in the production mix a country offers will reduce the demand for some of the production factors whereas for others it will increase it. If the other elements are constant. Paul Samuelson and Ronald Jones. while a country with a territory abundance tends to produce more food. 2. From this simple example it is easy to observe that labour (L) is a mobile factor and it can be used in both sectors of activity. The Competitive Advantage (Michael Porter¶s Model) The chain value Michael Porter identified four stages of development in the evolution of a country: . while a rise in the offer of territory will increase the production of food in the detriment of manufacturers. The gains from trade are bigger in the export sector of every country and smaller in the sector competed by imports. they create an integrated global economy whose manufacture and food production is equal with the sum of the two countries¶ productions. whatever the price.Development based on investments . 2 3. If a country doesn¶t trade.Development based on factors . In this case. an increase in capital will mean an increase in marginal productivity from the manufactured sector. The exchange rate (the rapport between the export prices and the import prices) is determined by the crossing/intersection between the two curves. the production for a good equals the consumption.Development based on innovation . two American economists. trade may benefit both countries involved. Products like food (X) are made by using territory (T) and labour (L) while manufactured products (Y) use capital (K) and labour (L).

the product is produced and consumed in the US. The country that has the comparativeadvantage in the production of the product changes from the innovating (developed)country to the developing countries.Domestic competition environment PRODUCT LIFE CYCLE THEORY The product life-cycle theory is an economic theory that was developed by RaymondVernon in response to the failure of theHeckscher-Ohlin modelto explain the observed pattern of international trade. NEW PRODUCT The IPLC begins when a company in a developed country wants to exploit atechnological breakthrough by launching a new. called by the author ³diamond´: .Development based on prosperity The theory is based on a system of determinants. Other advanced nations have consumers with similar desires andincomes making exporting the easiest first step in an internationalisation effort. In some situations.The capacity of internal factors .Competition comes from a few local or domestic players that produce their own unique product variations. which then export the product to developed countries. The product¶s design and production process becomes increasingly stable. the US now exports the product toother developed countries. mass-production techniques are developedand foreign demand (in developed countries) expands. A commonly used exampleof this is the invention. expensive products(low price elasticy). 2.Export to other industrial countries may occur at the end of this stage that allows theinnovator to increase revenue and to increase the downward descent of the product¶sexperience curve.The links between the industries . MATURING PRODUCT Exports to markets in advanced countries further increase through time making iteconomically possible and sometimes politically necessary to start local production.The modeldemonstrates dynamic comparative advantage.Such a market is more likely to start in a developed nation because more high-incomeconsumers are able to buy and are willing to experiment with new. Production is also more likely to start locally in order to minimizerisk and uncertainty: ³a location in which communication between the markets and theexecutives directly concerned with the new product is swift and easy. The IPLC international trade cycle consists of three stages: 1. growth and production of the personal computer with respect tothe United States. innovative product on its home market.In the new product stage. Foreign directinvestments (FDI) in production . In the standardized product stage. no exporttrade occurs. After the product becomes adopted and used in the world markets. productiongradually moves away from the point of origin.The model applies to labor-saving and capital-using products that (atleast at first) cater to high-income groups. Furthermore. the product becomesan item that is imported by its original country of invention. In the maturing product stage. and in which a widevariety of potential types of input that might be needed by the production units are easilycome by´. production moves todeveloping countries.The specific of the domestic market .. The theory suggests that early in a product's life-cycle allthe parts and labor associated with that product come from the area in which it wasinvented. easier access to capital markets exists to fund new product development.

The IPLC model was widely adopted as the explanation of the ways industriesmigrated across borders over time. Furthermore. . The firm begins to focuson the reduction of process cost rather than the addition of new product features. As aresult. production facilities will relocate to countries with lower incomes. and other established markets will have become increasingly price-sensitive. A country musthave a ready market. local competitors will get access to first hand information and can startto copy and sell the product. The machines that operate these plants often remain in the countrywhere the technology was first invented. ADVANTAGES: The model helps organisations that are beginning their international expansion or are carrying products that initially require experimentation to understand how thecompetitive playground changes over time and how their internal workings needto be refitted. As previously inadvanced nations.plants drive down unit cost because labour cost andtransportation cost decrease. most managers are ³myopic´. ³If economies of scale are beingfully exploited. e. the domestic market will have to import relatively capital intensive products fromlow income countries. A MNC will internally maximize ³offshore´ production to lowwage countries since it can move capital and technology around. Whatever market is left becomes shared between competitors who are predominately foreign. the textile industry. New product development in a country does not occur by chance. As aresult. Offshore production facilities are meant to serve localmarkets that substitute exports from the organisation¶s home market. Thisenables further economies of scale and increases the mobility of manufacturingoperations. Countries with high per capita incomes foster newly invented products. Competition from local firms jump start inthese non-domestic advanced markets. Labour can start to be replaced by capital. The innovator's originalcomparative advantage based on functional benefits has eroded. the principal markets become saturated. No two countries exist with identical local marketconditions.g. To counter price competition and trade barriers or simply to meet local demand. According to Vernon. The model can be used for product planning purposes ininternational marketing. Production is only movedoutside the home market when a ³triggering event´ occurs that threatens exportsuch as a new local competitor or new trade tariffs.The demand of the original product in the domestic country dwindles from the arrival of new technologies. Production stillrequires high-skilled. the product and its production process become increasingly standardised. Managers act when the threathas become greater than the risk in or uncertainty from reallocating operationsabroad. high paid employees. 3. Export orders will begin to come from countrieswith lower incomes. Countries with lower per capita incomes will focus on adapting existing products to create lower priced versions. but not labour. an able industrial capability and enough capital or labour tomake a new product flourish. STANDARDISED PRODUCT During this phase. the principal difference between any two locations is likely to be labour costs´. Vernonwas able to explain the logic of an advanced. high income country such as theUSA that exports slightly more labour-intensive goods than those that are subjectto competition from abroad.

as activities. assume that an individual has a choice between two telephoneservices.The model¶s validity was proved by empirical evidence from the teletransmissionequipment industry in the post-war years. and because of themodes and locations of life necessarily associated with them. Investments in an existing portfolio of production facilities made it harder to relocate plants. leadinghim or her to choose the less expensive service. competitors were able to imitate product at muchhigher speeds than previously envisioned and MNCs had built up an existingglobal network of production facilities that enabled them to launch products inmultiple markets simultaneously. he recognised that thisassumption was no longer valid. preferences as between products play a role in the determination of values. and relative prices are held to be determined solely by preferences between products and by thetechnical coefficients of production. In the comparative-cost doctrine. that individual may have toreduce the number of times he or she goes to the movies each month. the problem of choice between alternative products . The business landscape had Opportunity cost theory Let's look at another example to demonstrate how opportunity cost ensuresthat an individual will buy the least expensive of two similar goods when given thechoice. DISADVANTAGES: Vernon¶s main assumption was that the diffusion process of a new technologyoccurs slowly enough to generate temporary differences between countries in their access and use of new technologies. Income differences between advanced nationshad dropped significantly. and also preferences between employment and (voluntary) non-employment of the factors. In real-cost value theorizing. Giving up theseopportunities to go to the movies may be a cost that is too high for this person.The opportunity-cost doctrine. but so also do preferences betweenoccupations for their own sakes. in its original form and in the only form in which its pretensions to being a revolutionary departure from real-cost value theorizing have any basis. In this theory the only true cost is foregone product. If he or she were to buy the most expensive service. pleasurable or painful. and even betweenexistence and non-existence of the factors. By the late 1970¶s. The model assumed integrated firms that begin producing in one nation. For example. where the problem of trade policy is dealt with from the point of view of under what foreign-trade policy a unit of a given commodity will be procured at the minimum real cost. The model is best applied to consumer-oriented physical products based on a new technology at a time whenfunctionality supersedes cost considerations and satisfies a universal need. followed by exporting and then building facilities abroad. treated choice between alternative products (or choice between the utilitiesderivable from the consumption of alternative products) as the only choice significant for price determination.

Any point on the curve .is abstracted from.5who claimedfor it that it was adequate for the purpose and had the advantage over the doctrine of comparative costs that the use of the factors in variable proportions presented nodifficulties for itThe theory is presented in chart terms of so-called indifference curves.The opportunity-cost theory was first applied to the problem of gain or loss from foreigntrade as a substitute for the doctrine of comparative real cost by Haberler . but free scope is leftfor consideration of all the other relevant alternatives between which choice must bemade.