chapter International Trade Theory McGraw-Hill/Irwin Global Business Today, 5e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 5

5 - 3 Chapter 5: International Trade Theory INTRODUCTION In this chapter: Theories that explain why it is beneficial for a country to engage in international trade are presented The patterns of international trade that is observed in the world economy are explained

5 - 4 Chapter 5: International Trade Theory AN OVERVIEW OF TRADE THEORY Free trade refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country or what they can produce and sell to another country.

5 - 5 Chapter 5: International Trade Theory The Benefits of Trade The Pattern of International Trade Trade Theory and Government Policy

5 - 6 Chapter 5: International Trade Theory MERCANTILISM Mercantilism, which emerged in England in the mid-16 th century, asserted that it is in a country’s best interest to maintain a trade surplus-- to export more than it imports.

5 - 7 Chapter 5: International Trade Theory ABSOLUTE ADVANTAGE In 1776, Adam Smith attacked the mercantilist assumption that trade is a zero-sum game and argued that countries differ in their ability to produce goods efficiently, and that a country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it.

5 - 8 Chapter 5: International Trade Theory COMPARATIVE ADVANTAGE In 1817, David Ricardo argued that it makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce more efficiently itself.

5 - 9 Chapter 5: International Trade Theory The Gains from Trade Qualifications and Assumptions Extensions of the Ricardian Model

Chapter 5: International Trade Theory HECKSCHER-OHLIN THEORY Hecksher and Ohlin argued that that countries will export goods that make intensive use of those factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce. The Leontief Paradox

Chapter 5: International Trade Theory THE PRODUCT LIFE CYCLE THEORY In the mid-1960s, Raymond Vernon proposed the product life- cycle theory that suggested that as products mature both the location of sales and the optimal production location will change affecting the flow and direction of trade. Evaluating the Product Life Cycle Theory

Chapter 5: International Trade Theory NEW TRADE THEORY New trade theory suggests that because of economies of scale (unit cost reductions associated with a large scale of output) and increasing returns to specialization, in some industries there are likely to be only a few profitable firms

Chapter 5: International Trade Theory Increasing Product Variety and Reducing Costs Economies of Scale, First Mover Advantages and the Pattern of Trade Implications of New Trade Theory

Chapter 5: International Trade Theory NATIONAL COMPETITIVE ADVANTAGE: PORTER’S DIAMOND Porter’s 1990 study tried to explain why a nation achieves international success in a particular industry and identified attributes that promote or impede the creation of competitive advantage.

Chapter 5: International Trade Theory Factor Endowments Demand Conditions Related and Supporting Industries Firm Strategy, Structure, Rivalry Evaluating Porter’s Theory

Chapter 5: International Trade Theory FOCUS ON MANAGERIAL IMPLICATIONS There are at least three main implications for international businesses: Location First-Mover Advantages Government Policy