Developed by Cool Pictures and MultiMedia Presentations Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Developed by Cool Pictures and MultiMedia Presentations Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.

Developed by Cool Pictures and MultiMedia Presentations Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. What We Are Striving To Accomplish 1.To understand how and why countries trade with each other and to consider the impact of trade on the welfare of all nations. 2.To trace the roots of classical trade theory, from the work of early theorists, Adam Smith and David Ricardo, to the evolution of factor proportions theory. 3.To examine the arguments of later theorists, who focused not on factors of production or factor proportions but on the product itself and its life cycle. 4.To understand the importance of recent contributions to trade theory, notably Paul Krugman’s explanations of economics of scale and Michael Porter’s research on global competitiveness. 5.To explore the similarities and distinctions between international trade and international investment. 6.To consider the decision process involved in foreign direct- investment strategies.

Developed by Cool Pictures and MultiMedia Presentations Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Evolution of Trade Three events reflect the evolution of trade:  Collapse of the feudal society autarky or self-sufficient  Mercantilist philosophy emergence export of goods in exchange for gold  Life cycle of the colonial systems of the European nation-states impacted by the Industrial Revolution

Developed by Cool Pictures and MultiMedia Presentations Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Why Trade? Trade is a relationship between costs and benefits to each trading partner. Why countries trade is difficult to answer so several theories have developed and evolved over the past two centuries.

Developed by Cool Pictures and MultiMedia Presentations Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Evolution of Trade Theory The chart provides an efficiency comparison of two countries.

Developed by Cool Pictures and MultiMedia Presentations Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Absolute Advantage and the Division of Labor Theory first introduced by Adam Smith Absolute advantage - produce a product using the fewest labor hours. Division of labor - specialization in the production process dividing the process into distinct stages performed by exclusively by one individual. Applied to countries based on their product specialization and ability to produce more for less.

Developed by Cool Pictures and MultiMedia Presentations Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Comparative Advantage and Factor Proportions Comparative advantage - David Ricardo (1819) A comparative advantage means that no matter how good (or bad) you are at producing something, there's always something that you're best (or least worst) at doing. Countries should focus on producing what they are best at and trade for the other products. Factor Proportions - Heckscher-Ohlin A country which is capital-abundant will export the capital-intensive good. Likewise, the country which is labor-abundant will export the labor-intensive good. Each country exports that good which it produces relatively better than the other country and imports what it does not.

Developed by Cool Pictures and MultiMedia Presentations Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Leontief Paradox and Overlapping Product Ranges Theory Leontief Paradox - 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. Overlapping Product Ranges Theory - Staffan Burenstam Linder Similarity of demands influence global trade in manufactured goods. Countries with similar per-capita income levels would see the most intensive trading since they would be more likely to have overlapping product ranges or market segments.

Developed by Cool Pictures and MultiMedia Presentations Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Input-Output Analysis A method for estimating market activities. Considered potential that measures the factor inflows into production and the resultant outflow of products.

Developed by Cool Pictures and MultiMedia Presentations Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Product Cycle Theory Is supply-side and demand-side in orientation. Three stages: 1. New Product - Highly skilled labor and large capital investment, flexible, high cost of production. 2. Maturing Product - Standardized process, decline in flexibility and highly skilled labor, sales and competition increases. 3. Standardized Product - Product produced by country with cheapest unskilled labor, low profitability, fierce competition, end of product cycle. Important to match the product by its maturity stage to location of production to maintain competitiveness.

Developed by Cool Pictures and MultiMedia Presentations Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Product Cycle Theory Limitations Most appropriate for technology-based products. Most relevant to products that eventually fall victim to mass production.

Developed by Cool Pictures and MultiMedia Presentations Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. New Trade Theory Imperfect Markets and Trade Theory - Paul Krugman A firm possessing internal economies of scale can monopolize an industry (creating an imperfect market) - produce more products, lower and set market prices, sell more products. Other firms enter the market on the abandoned market ranges. Intra-industry trade and product differentiation usually occurs as a firm narrows it’s product line. Competitive Advantage of Nations - Michael Porter Innovation is what drives and sustains competitiveness. The dimensions of competitiveness were categorized into four determinants or “the diamond of national advantage”.

Developed by Cool Pictures and MultiMedia Presentations Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Mobility of capital makes foreign direct investments possible Firms expanding across boarders may seek the following as possible sources of profit or opportunity: Natural resources Factor advantages Knowledge Security Markets Firms also exploit the following imperfections in the factor and product markets: Market access (import substitution) Factor mobility Management International Investment Foreign Trade Statistics

Developed by Cool Pictures and MultiMedia Presentations Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Foreign Direct Investment Strategies The Direct Foreign Investment Decision Sequence What are firm’s expansion strategies? How much control? Magnitude of capital to risk? Degrees of ownership vary - what’s important? What degree of equity control? Cost? Established customers and suppliers?