GLOBAL & INTERNATIONAL

BUSINESS CONTEXTS
Module Code : OUbs 009222

LESSON 1 : Introducing International

Trade Theory

Anju Mungur
Bsc , PGCE , MBA IB
International Trade Theory
The Classical Trade Theory V/S The Modern Trade Theory

Modern trade theories:

• explain links among natural country advantages,
government action, and industry characteristics
that enable such exchange to happen

• Product Life Cycle Theory

• Global Rivalry Theory
• Porter’s Diamond of National Competitive
• Advantage
Mercantilism Theory by Thomas
Mun (1630s) : mid-16 century
th

•A nation’s wealth depends on accumulated

treasure
•Gold and silver are the currency
of trade.
•Theory says you should have a trade
surplus.
Maximize exports through subsidies.
Minimize imports through tariffs and Global Funding

quotas.
Criticism : Trade should be free and benefits all parties
instead to only limited parties . (WTO)
Theory of Absolute Advantage
• Adam Smith: Wealth of Nations (1776).
• Capability of one country to produce more of a
product with the same amount of input than
another country.
• Produce only goods where you are most efficient,
trade for those where you are not efficient.
• Trade between countries is, therefore, beneficial.
• Assumes there is an absolute advantage
balance among nations.
• Ghana/cocoa Italy / Ceramics
• Korea /Rice India, China / Textile & low
• cost manufacturing
Example of Absolute Advantage
• Resources Required to Produce 1 Ton of Cocoa and
Rice
• Cocoa Rice
Ghana 10 20

S. Korea 40 10

• From the above table, it can be concluded that Ghana has

an Absolute Advantage in producing Cocoa whereas the
South Korean has much benefits in producing rice.
• Conclusion : A nation’s wealth is no more dependent on Gold and Silver but at
the same time it consider other aspects like inhabitant’s living standard, Climate
other factors.
COMPARATIVE ADVANTAGE THEORY

•
David Ricardo: Principles of Political Economy (1817).
• Extends free trade argument
• Efficiency of resource utilization leads to more
productivity.
• Should import even if country is more efficient in the
product’s production than country from which it is
buying.
• Look to see how much more efficient. If only
comparatively efficient, than import.
•Makes better use of resources
•Trade is a positive-sum game.
COMPARATIVE ADVANTAGE THEORY : Example

• Resources required to produce :

• 1 Tn of Sugar 1 Tn of Vanilla
• 30 Mauritius 10
• 8 Madagascar 4
• From the above figure ,In Mauritius, with 30 Units of resources for the
production of 1 Ton of Sugar ,it has to produce 3Tons of Vanilla.
Therefore, the opportunity cost of 1 Ton of Sugar production is 3 Tons of
vanilla.

• Madagascar to produce 1 ton of sugar requests for 8 units of resources

but can produce 2 tons of vanilla. Hence, the opportunity cost of 1 ton of
sugar is equal to 2 tons of vanilla.

• In a nutshell, we note that Madagascar has a lower opportunity cost as

compared to Mauritius in both situation. However, Madagascar has a
comparative advantage in sugar production
 Heckscher (1919)-Ohlin (1933) Theory
:

• Export goods that intensively use factor

endowments which are locally abundant.
• Corollary: import goods made from locally
scarce factors.
• Patterns of trade are determined by
differences in factor endowments - not
productivity.
• Remember, focus on relative advantage,
not absolute advantage
 Product Life Cycle Theory
: (Raymond Vernon, 1966)

Article in the Quarterly Journal of

Economics.
As products mature, both location of
sales and optimal production changes.
Affects the direction and flow of
imports and exports.
Globalization and integration of the
economy makes this theory less valid.
International Product Trade
Cycle Model
High Income Countries production

Exports Imports consumption

Q
u 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

a Medium Income Countries

Exports
n
ti
t Imports
y 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Low Income Countries

Exports
Imports
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Time
New Product Maturing Product Standardized Product Figure 4.5
Stages of Production Development 4-22
© McGraw Hill Companies, Inc.,2000
 Product Life Cycle Theory
: (Raymond Vernon, 1966)

Producers based in advanced countries where

labor costs were lower than the United States
might now be able to export to the United
States

If cost pressures were intense, developing

countries would acquire a production
advantage over advanced countries

Production became concentrated in lower-cost

foreign locations, and the U.S. became an
importer of the product
 :
Global Rivalry Theory (Krugman & Lancaster ; 2008)

• Nobel Prize in 2008

 New Trade theory emerged in the 1980’s
Theories focus more on MNC’s and their efforts to
gain competitive advantages against other Global
firms for sustainability.
• Strategies for competitive advantages :
• Barriers to entries
• Sustaining existing firms while creating obstacles to new ones
• Research & Development
• Intellectual Property Rights
• Economies of Scale ( Nike, Adidas shifting in LDC’s)
• Strategic alliance (Airlines Industry)
• Exploiting Learning Curve through Cost reduction and adding
Value eg, Cost Leadership Strategy
 Porter’s Diamond
(Harvard Business School, 1990)

• The Competitive Advantage of Nations.

• Looked at 100 industries in 10 nations.

• Thought existing theories didn’t go far
enough.
• Question:
• “Why does a nation achieve international
success in a particular industry?”
• The Diamond Model regroups 4 main
attributes of a nation to shape its environment
:
 Porter’s Diamond(Harvard Business School, 1990)

• The four attributes :

• Factor endowments: nation’s position in factors of production

such as skilled labor or infrastructure necessary to compete in
a given industry
• Demand conditions: the nature of home demand for the
industry’s product or service.
• Firm strategy, structure and rivalry:the conditions in the
nation governing how companies are created, organized, and
managed and the nature of domestic rivalry.
• Related and supporting industries: the presence or
absence in a nation of supplier industries or related industries
that are nationally competitive.
Porter’s Diamond
Determinants of National Competitive Advantage

Firm Strategy,
Structure and
Rivalry

Factor Endowments Demand Conditions

Related and
Supporting
Figure 4.6 Industries

© McGraw Hill Companies, Inc.,2000 4-31

Activities

• (a)Define international trade and elaborate on its

benefits?

• (b) With relevant examples, summarize briefly the

absolute and comparative advantage theories; HO
theory; Global Strategic Rivalry theory

• (c) Describe how a business may use the national

diamond model to develop its business strategies.