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Importance of International Trade
• When an American Buys a Sony TV…… • International Tourists exchanges Rupee with Euro… • What is a Dell PC? Monitors PCBs Drivers Printers Box builds Europe, Asia, (Philips, Nokia, Samsung, Sony, Acer) Asia, Scotland, Eastern Europe (SCI, Celestica) Asia, Mainly Singapore (Seagate, Maxtor, Western Digital) Europe (Barcelona) Asia, Eastern Europe (Hon Hai / Foxteq)
Why do countries trade?
• Causes for trade:
– Availability of products (natural resources, new products, etc.) – International price differential as a consequence of:
• • • • Productivity differential Differences in technology Differences in factor endowments Economies of scale
– Product differentiation and market structure
and philosophers) wrote essays on international trade that advocated an economic philosophy known as Mercantilism. • Countries have to do their best to increase exports and restrict imports. • The surplus in trade balance will result in an inflow of precious metals. • The more precious metals means a richer and more powerful nation. • In their view. .Mercantilist's view on trade • The Mercantilists’ View on Trade In the 17th century a group of men (merchants. gold and silver. government officials. a country becomes rich if it exports more than it imports. bankers.
e. zero-sum-game). a country gains from trade only at the expense of others. • In contrast. • Mercantilits advocated strict government control of economic activity because gain from trade comes at the expense of other nations (i. • Wealth of nations was measured by the stock of metals they possess. today we measure wealth of a nation by its stock of human. man-made.Mercantilist's view on trade • Since all countries cannot have surplus at the same time and because the stock of metals is fixed in the short run. . and natural resources available for producing goods and services.
• Government Subsidies of exports of certain industries are paid by tax payers in form of higher taxes. • Government imports restrictions are paid by consumers in the form of higher taxes. no country could sustain a surplus on the balance of trade. . in the Long run.Flaws Of Mercantailism • According to Davis Hume.
produce a product using the fewest labor hours. .Absolute Advantage and the Division of Labor • Theory first introduced by Adam Smith – 1776 • Absolute advantage . • Applied to countries based on their product specialization and ability to produce more for less. • Division of labor .specialization in the production process dividing the process into distinct stages performed by exclusively by one individual.
Absolute Advantage Theory • A tailor does not make his own shoes. . • Both nations will gain from trade. • He exchanges a suit for shoes • Each nation specialize and exchange commodities which have absolute advantage.
but inefficient in growing Wheat. • On the other hand. . • India specialize in Cotton and US in Wheat.Absolute Advantage Theory • India is efficient in growing Cotton. US. is efficient in growing Wheat. but inefficient in Cotton. • India has an absolute advantage over US in the cultivation of Cotton.
US gains 1 yard C. or ¼ man hour India Exchanges.Absolute Advantage Theory US 5C India 6W Wheat (Bushels/man hour) Cloth (Yards/man hour) 6 1 4 5 US Exchanges. or 5 man hours Both countries gain . 6 bushels W = 5 yard C. India gains 5 bushel W. 5 yard C = 6 bushels W.
Portugal can produce both wine and cloth cheaper than England • Portugal has an absolute advantage in both • Opportunity Cost . what happens? • For example. • If one country is efficient in both products than other.Comparative Advantage Theory • Followed Smith • David Ricardo: Principles of Political Economy (1817).
Comparative Advantage Theory • David Ricardo showed that such a country may still derive benefits from International Trade. • A country which have absolute advantage in production of all goods can specialize in the production of those goods that the country produces most efficiently & buy those goods that it produces less efficiently from other countries. .
Comparative Advantage Theory Labour Cost of production (in hours) 1 Unit of Wine 1 Unit of Cloth Portugal England 80 120 90 100 .
Comparative Advantage Theory: Gains from Trade • If no trade. in England – 120 hours = 1 W – 100 hours = 1 C – 1 wine will cost 120/100 or 1.2 cloth .
Comparative Advantage Theory: Gains from Trade • In Portugal – 80 hours = 1 W – 90 hours = 1 C – 1 wine will cost 80/90 or 0.89 cloth .
Comparative Advantage Theory: Gains from Trade Opportunity Cost of production 1 Unit of Wine 1 Unit of Cloth Portugal 80/90 = 8/9 90/80 = 9/8 England 120/100 = 12/10 100/120 = 10/12 .
1 wine will cost 80/90 or 0. she would gain.Comparative Advantage Theory: Gains from Trade 1.83 In Portugal.13 0. .89 units of cloth in exchange of 1 unit of wine.89 cloth – If Portugal could import more than 0.
Comparative Advantage Theory: Gains from Trade 1.83 • In England.1 wine will cost 120/100 or 1.89 – 1.2 cloth .13 0.2 cloth – Portugal can export 1 unit of wine to England and get an exchange between 0.
if 1Wine exchanges for 1 cloth.83 • In international market. she has to give up 1. because.13 0. in the absence of trade. • England export cloth and import wine. advantageous for England.2 cloth.2 Cloth for 1 Wine and save 0.Comparative Advantage Theory: Gains from Trade 1. .
83 • Without trade. • Save 10 labour. • Now she can make 1 Wine by 80 hours of labour and exchange 1Wine for 1Cloth.13 0. • Both nations gains from trade than isolation . Portugal has to give up 1.13 wine to get 1 unit cloth. Portugal export wine and import cloth.Comparative Advantage Theory: Gains from Trade 1.
. • A country that is relatively capital abundant should specialize in the production of relatively capitalintensive goods.Heckscher (1919)–Ohlin(1933) Trade Model (Factor Proportion Theory) • A country that is relatively labor abundant should specialize in the production of relatively laborintensive goods. • It should then export that labor intensive good in exchange for capital-intensive goods. • It should then export it in exchange for labor-intensive goods.
.Heckscher-Ohlin Trade Model (Factor Proportion Theory) • According to Heckscher and Ohlin. • Goods differ according to the types of factors that are used to produce them. • Difference in factor endowment leads to difference in factor costs. ―Factor Endowment (types of resources) varies from country to country.
• On the other hand to produce one unit of Good Y 2 units of labour and 4 units of capital are required.Heckscher-Ohlin Trade Model (Factor Proportion Theory) • One unit of Good X is produced with 4 units of labor and 1 unit of capital . . it is called as capital intensive good. • Example: Leather goods are labor intensive while computer chips are capital intensive. Since it uses more amount of capital when compared to Good X. it is classified as a labor intensive good. Since it requires more units of labor.
Heckscher-Ohlin Trade Model (Factor Proportion Theory) • According to HO Theory.abundance of unskilled labour • US – abundance of capital • China – abundance of labour • Australia & Canada – abundance of land . • Ex: Saudi Arabia-abundance of crude oil reserves • India . ―A country will have a comparative advantage in producing products that intensively use resources (factors of production) it has in abundance.
Considered potential that measures the factor inflows into production and the resultant outflow of products.Leontief Paradox (1953) • Wassily Leontief (1950) Tested the Factor Proportions theory on goods imported and exported by the United States. Leontief reached a paradoxical conclusion that the US—the most capital abundant country in the world by any criterion—exported labor-intensive commodities and imported capital.intensive commodities. . • Input-Output Analysis: A method for estimating market activities.
. • As products mature. • Most appropriate for technology-based products. • Affects the direction and flow of imports and exports. • Most relevant to products that eventually fall victim to mass production. both location of sales and optimal production changes. • Globalization and integration of the economy makes this theory less valid.Product Life-Cycle Theory (Raymond Vernon. 1966) • Article in the Quarterly Journal of Economics.
Product Life Cycle Theory • There are 4 stages in Product Life cycle:– – – – Introductory Stage Maturing Stage Standardized product Stage Declining Stage .
– Better to keep production facilities close to the markets & to the centre of decision making.Product Life Cycle Theory • INTRODUCTORY STAGE:– Also known as Innovation stage. – Companies may sell a small part of their production in foreign markets – Exports . – In this stage. – Early production generally occurs in the domestic market. A firm develops & introduces an innovative product.
– Set up production unit in host country to minimize distribution cost – Internationalization of Production. . Demand of product expands domestically & abroad.Product Life Cycle Theory • MATURING STAGE:– In this stage. – Domestic production reaches its peak – Foreign competitors expands productive capacity.
– Stiff competition from home as well as other developed countries. Product become more standardized & prices becomes the main competitive weapon. – Domestic production slumps.Product Life Cycle Theory • STANDARDIZED PRODUCT STAGE:– In this stage. – Production techniques are no longer exclusive & innovative. .
Product Life-Cycle Theory 160 140 120 100 80 60 40 20 0 160 140 120 100 80 60 40 20 0 160 140 120 100 80 60 40 20 0 United States Exports Other Advanced Countries Imports Exports Imports Developing Countries Exports Imports New Product Maturing Product Standardized Product production consumption Stages of Production Development .
not the firm) .New Trade Theory • Imperfect Markets and Trade Theory – Paul Krugman • Economics of Scale Internal Economies of Scale (the cost per unit depends on size of the individual firm) External Economies of Scale(the cost per unit depends on the size of the industry.
the creation of a better transportation network. resulting in a subsequent decrease in cost for a company working within that industry. External Economies of Scale: External economies of scale occur outside of a firm. Thus. within an industry. external economies of scale are said to have been achieved. when an industry's scope of operations expands due to. for example. all firms within the industry will benefit. . With external ES.Internal and External Economies of Scale Internal Economies of Scale: When a company reduces costs and increases production. internal economies of scale have been achieved.
sell more products. Intra-industry trade and product differentiation usually occurs as a firm narrows it’s product line.produce more products. • Other firms enter the market on the abandoned market ranges.New Trade Theory • A firm possessing internal economies of scale can monopolize an industry (creating an imperfect market) . lower and set market prices. .
ability to enhance economies of scale increase. learning effects also exist. . – Specialization increases output. – Learning effects are cost savings that come from ―learning by doing‖.New Trade Theory • Began to be recognized in the 1970s. • Deals with the returns on specialization where substantial economies of scale are present. • In addition to economies of scale.
• Competitors may emerge because ―they got there first‖.Application of the New Trade Theory • Typically. . fixed costs. • First-mover advantage. • Economies of scale may preclude new entrants. requires industries with high. • Some argue that it generates government intervention and strategic trade policy. • World demand will support few competitors.
1990) • The Competitive Advantage of Nations.Porter’s Diamond (Harvard Business School. – Thought existing theories didn’t go far enough. • Looked at 100 industries in 10 nations. • Question: ―Why does a nation achieve international success in a particular industry?‖ .
Porter’s Diamond Determinants of National Competitive Advantage Firm Strategy. Structure and Rivalry Factor Endowments Demand Conditions Related and Supporting Industries Porter claims that four kinds of variables will impact a local firm’s ability to use a country’s resources to gain a competitive advantage .
– Basic Factors: Land. Natural resources. – Advanced Factors: Technology. ―Favorable Factor conditions leads to favorable competitive conditions in the markets. Labor.Porter’s Diamond Determinants of National Competitive Advantage • FACTOR CONDITIONS:– Porter differentiated between Basic factors & Advanced factors. Infrastructure.‖ . Capital. – Porter said. etc. Education level of work force.
Porter’s Diamond Determinants of National Competitive Advantage • DEMAND CONDITIONS: – This represents the Consumer Demand. . – If the consumers are well aware then the firm has to develop high quality product & firm can compete internationally with good quality product & vice versa.
Porter’s Diamond Determinants of National Competitive Advantage • RELATED & SUPPORTING INDUSTRY:– These are the industries which gives input to the firms & have spill over effect. . – If the input produced by supporting Industry is superior i.e. of good quality. then the final product is also of good quality & the firm can compete internationally.
STRUCTURE & RIVALRY:– Different Countries have different ideologies. – The more is the rivalry.Porter’s Diamond Determinants of National Competitive Advantage • FIRM’S STRATEGY. Rivalry is important to develop world class product. the more pressure to produce good product & firm can compete internationally with good quality product. . – Therefore.
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