Bundoora Campus

ECO3BWE
Business in the World Economy

Lecture 2: The National

Perspective

INNOVATIVE | RESPONSIBLE | ENGAGED

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Outline
The national perspective to international business
– Why is it important?
A review of the mainstream theories of international trade

– Why do countries engage in international trade?

- Differences across countries (comparative advantage):
technology differences (The Ricardian Model) and factor
endowment differences (The Heckscher-Ohlin Model).
- Does everybody win from free trade? (The Specific Factors
Model)
- Revealed Comparative Advantage (RCA)
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The National Perspective

Why is it important?
1. Private international business operations are subject to national policies.
2. National policies are usually substantiated by international economics
models.
3. Some relevant national policies that affect international business are:
a. Decisions to liberalise trade for a specific sector or protect it from international
competition.
b. Engage with international trade organisations, multilateral, regional or bilateral trade
agreements.
c. Subsidise firms, sectors and promote industrial clusters.
d. Attract and support Foreign Direct Investments (FDIs).
e. Develop institutions and a business legal framework
f. Others…
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The National Perspective

Why is it important?
4. National policies that affect international business are interrelated and
shape the global market place.
5. All businesses should be able to (i) understand and interpret the business
environment in which they operate, (ii) the national policies implemented
and how they affect the business, (iii) the policies potentially implemented
in the future and, (iv) be able to respond accordingly.
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Theories of International Trade

Why do countries engage in international trade?

Comparative advantages
arise because of Ricardian Model
differences in technology
Countries differ in their
relative production capacity
(comparative advantages)
Comparative advantages
arise because of
Heckscher-Ohlin Model
differences in factor
endowments
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Theories of International Trade

Comparative Advantage in the Ricardian Model
- Consider the following situation:

Units of labour
UK France
required to produce*:
1L wine 2 5
1K rice 10 20

*
Where UK and France both have 1,000 units of labour each.
• Check the hand-written notes to determine absolute advantages,
comparative advantages and the gains from trade.
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Theories of International Trade

Comparative Advantage in the Heckscher-Ohlin Model
- To determine comparative advantages between two
given countries you need to consider:

1. Factor relative endowments (factor abundance)

2. Factor relative use in the production of a product (factor
intensity)
3. Assume technologies are the same
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Theories of International Trade

Comparative Advantage in the Heckscher-Ohlin Model
- To determine comparative advantages between two
given countries you need to consider:
Consider the following situation:

 Factor endowments LABOUR CAPITAL - What country is abundant in

GERMANY 180 90 capital/labour?
CAMBODIA 120 30

Units of factor to LABOUR CAPITAL

produce one unit of:
- What product is intensive in
CARS 10 20 capital/labour?
RICE 4 2
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Theories of International Trade

Comparative Advantage in the Heckscher-Ohlin Model
- To determine comparative advantages between two
given countries you need to consider:
Consider the following situation:

 Factor endowments LABOUR CAPITAL -  Cambodia is labour abundant

GERMANY 180 90
CAMBODIA 120 30 - This implies that Germany is capital abundant

Units of factor to LABOUR CAPITAL

produce one unit of: -  Rice is labour intensive

CARS 10 20
RICE 4 2 - This implies that cars are capital intensive
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Theories of International Trade

Comparative Advantage in the Heckscher-Ohlin Model

According to the HO Model, a country has the comparative

advantage in producing a product that uses intensively the
production factor in which the country is abundant.

 Factor endowments LABOUR CAPITAL

GERMANY 180 90 - Cambodia has the comparative advantage in the
production of rice.
CAMBODIA 120 30

Units of factor to LABOUR CAPITAL - Germany has the comparative advantage in the
produce one unit of: production of cars.
CARS 10 20
RICE 4 2
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Theories of International Trade

Does everyone win from free trade?

Models predict that specialisation on products with comparative advantage are

beneficial OVERALL for the country. But does everyone win?

The answer is no.

A model that illustrates who wins and who loses from

international trade is the Specific Factors Model.
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Theories of International Trade

Specific Factors Model

The Specific Factors Model focuses on the effects of free trade in

the short/medium run.

First think of, for example, the Ricardian Model. The assumption
is that labour is the only production factor and is fully mobile
across sectors.

This implies that after engaging in the process of specialisation,

labour only needs to shift to the benefited sector. There are no
losers.
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Theories of International Trade

Specific Factors Model
Now to illustrate how sectors may be worse off after free trade think of the
following situation in the Specific Factors Model.

Land
Agriculture
Labour
Manufacturing
Capital

Land is specific to agriculture, capital is specific to manufacturing, and labour is mobile

between sectors.

What happens to the owner of capital if after trade the country specialises in agriculture?
• The owners of capital will lose because, at least in the short run, capital cannot be used in
agriculture production.
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Theories of International Trade

Free trade is under most circumstances expected to be
beneficial for the overall welfare of a country. However, it
produces winners and losers within country.

Governments know this when they design and implement

policies to engage in international trade.

Losers should be compensated or supported during the

transition (for example through training in the case of labour) to
another sector.

Businesses should be able to understand the market context and

respond or anticipate policies that may negative affect them.
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Theories of International Trade

Revealed Comparative Advantages (RCAs)

The principle of comparative advantage in explaining

international trade is a powerful idea.

However, it is difficult to use the theory to determine actual

countries’ comparative advantages and predict patterns of trade.

One useful approach is to look at what countries actually trade

relative to other countries in the world. This approach is called
Revealed Comparative Advantage (RCA).

Check the reading: “Changes in global trade shaping the Australian economy”. 2018.
Department of Industry, Innovation and Science, Australian Government.