1. 5 International Trade Copyright © 2014 Pearson Education, Inc.

2. 5 - 2 Copyright © 2014 Pearson Education, Inc. Chapter Objectives Describe the relationship between international trade volume and world output, and identify overall trade patterns Describe mercantilism and explain its impact on world powers and their colonies Explain the theories of absolute advantage and comparative advantage Explain the factor proportions and international product life cycle theories Explain the new trade and national competitive advantage theories

3. Walmart Walmart and others import from China China imports from other countries, too Causes dramatic growth in global trade 5 - 3 Copyright © 2014 Pearson Education, Inc.

4. 5 - 4 Copyright © 2014 Pearson Education, Inc. International Trade Purchase, sale, or exchange of goods and services across national borders People have larger selection of products Important engine for job creation

5. 5 - 5 Copyright © 2014 Pearson Education, Inc. Trade and World Output World trade 80% merchandise 20% services World output impacts trade Growing output = growing trade Sluggish output = sluggish trade World trade grows faster than world output

6. 5 - 6 Copyright © 2014 Pearson Education, Inc. World’s Top Exporters

7. 5 - 7 Copyright © 2014 Pearson Education, Inc. Trade Patterns Merchandise trade among: Low- and middle-income nations High-income nations High-income and low- and middle-income nations

8. 5 - 8 Copyright © 2014 Pearson Education, Inc. Who Trades with Whom?

9. 5 - 9 Copyright © 2014 Pearson Education, Inc. Trade Dependence and Independence Potential effects of dependence: + Infuses needed capital + Creates jobs and raises wages + Imports technology and skills – Economic problems transferred – Political turmoil can spill over Total dependence Total independence

10. 5 - 10 Copyright © 2014 Pearson Education, Inc. Discussion Question What are the patterns of global and regional trade flows that we see among nations?

11. 5 - 11 Copyright © 2014 Pearson Education, Inc. Answer to Discussion Question 60 percent of world merchandise trade occurs among high-income countries. 34 percent of world merchandise trade occurs among high-income countries and low- and middle-income nations. About 6 percent of trade occurs only among low- and middle- income nations. Intra-regional trade accounts for 71 percent of Europe’s exports, 52 percent of Asia’s exports, and around 48 percent of North America’s exports. This century is called the “Pacific century” due to expected growth in Asia and a shift in trade from the Atlantic to the Pacific Ocean.

12. 5 - 12 Copyright © 2014 Pearson Education, Inc. Trade Theory Timeline

13. 5 - 13 Copyright © 2014 Pearson Education, Inc. Foundations of Mercantilism Nations accumulate financial wealth by encouraging exports and discouraging imports Three pillars: ▪ Maintain trade surplus ▪ Government intervention ▪ Exploit colonies

14. 5 - 14 Copyright © 2014 Pearson Education, Inc. Flaws of Mercantilism ‒ World trade is a zero-sum game ‒ Limits colonies’ market potential ‒ Constrains output and consumption

15. 5 - 15 Copyright © 2014 Pearson Education, Inc. Absolute Advantage Ability of a nation to produce a good more efficiently than any other nation (greater output using same or fewer resources) Specialization and trade allows each to produce and consume more 1 resource unit = 1 ton rice or 1/5 ton tea Riceland 1 resource unit = 1/6 ton rice or 1/3 ton tea Tealand

16. 5 - 16 Copyright © 2014 Pearson Education, Inc. Trade Gains: Absolute Advantage Specialization and trade: + Riceland gets five times more tea than it would have produced itself + Tealand gets two times more rice than it would have produced itself

17. 5 - 17 Copyright © 2014 Pearson Education, Inc. Comparative Advantage Inability of a nation to produce a good more efficiently than other nations, but an ability to produce that good more efficiently than it does any other good Specialization and trade allow each to produce and consume more 1 resource unit = 1 ton rice or 1/2 ton tea Riceland 1 resource unit = 1/6 ton rice or 1/3 ton tea Tealand

18. 5 - 18 Copyright © 2014 Pearson Education, Inc. Trade Gains: Comparative Advantage Specialization and trade: + Riceland gets two times more tea than it would have produced itself + Tealand gets two times more rice than it would have produced itself

19. 5 - 19 Copyright © 2014 Pearson Education, Inc. Assumptions and Limitations Nations strive only to maximize production and consumption Only two countries produce and consume just two goods No transportation costs of traded goods Labor is the only resource used to produce goods and it cannot cross borders Specialization does not create efficiency and improvement gains

20. 5 - 20 Copyright © 2014 Pearson Education, Inc. Discussion Question When a nation cannot produce a good more efficiently than other nations, but it can produce that good more efficiently than it does any other good, we say this is a case of __________. a. Absolute advantage b. Comparative advantage c. Mercantilism

21. 5 - 21 Copyright © 2014 Pearson Education, Inc. Answer to Discussion Question When a nation cannot produce a good more efficiently than other nations, but it can produce that good more efficiently than it does any other good, we say this is a case of __________. a. Absolute advantage b. Comparative advantage c. Mercantilism

22. 5 - 22 Copyright © 2014 Pearson Education, Inc. Factor Proportions Theory Countries produce and export goods that require resources (factors) in abundance, and import goods that require resources in short supply Two factor types Land and Capital Labor

23. 5 - 23 Copyright © 2014 Pearson Education, Inc. Leontief Paradox Research found evidence opposite of that predicted by the factor proportions theory: U.S. exports are more labor-intensive than U.S. imports Possible explanations: Theory assumes nation’s production factors to be homogeneous Theory is better predictor when expenditures on labor are considered

24. 5 - 24 Copyright © 2014 Pearson Education, Inc. International Product Life Cycle A company begins by exporting its product and later undertakes foreign direct investment as a product moves through its life cycle Source: Raymond Vernon and Louis T. Wells, Jr., The Economic Environment of International Business, 5 th ed. (Upper Saddle River, N.J.: Prentice Hall, 1991), p. 85.

25. 5 - 25 Copyright © 2014 Pearson Education, Inc. New Trade Theory Fundamentals  Gains from specialization and economies of scale  Companies first to market create barriers to entry  Government may help by assisting home companies First-mover advantage  Economic and strategic advantage of being first to enter an industry  May create a formidable barrier to market entry for potential rivals

26. 5 - 26 Copyright © 2014 Pearson Education, Inc. Discussion Question Briefly describe the new trade theory. Does its focus on productivity put it at odds with the theory of comparative advantage and factor proportions theory?

27. 5 - 27 Copyright © 2014 Pearson Education, Inc. Answer to Discussion Question New trade theory says that there are gains from specialization and economies of scale, companies first to market create barriers to entry, and government is helpful if it assists its home-based companies. Because new trade theory emphasizes productivity rather than a nation’s resources, it is in line with the theory of comparative advantage and at odds with factor proportions theory.

28. 5 - 28 Copyright © 2014 Pearson Education, Inc. National Competitive Advantage Nation’s competitiveness in an industry depends on the industry’s capacity to innovate and upgrade, which in turn depends on four main determinants (plus government and chance) Nation’s competitiveness in an industry depends on the industry’s capacity to innovate and upgrade, which in turn depends on four main determinants (plus government and chance) Factor conditions Demand conditions Firm strategy, structure, and rivalry Related and supporting industries

29. 5 - 29 Copyright © 2014 Pearson Education, Inc. Factor Conditions Basic Factors Advanced Factors

30. 5 - 30 Copyright © 2014 Pearson Education, Inc. Demand Conditions Sophisticated home-market buyers drive companies to improve existing products and develop entirely new products and technologies This should improve the competitiveness of the entire group of companies in a market

31. 5 - 31 Copyright © 2014 Pearson Education, Inc. Related and Supporting Industries Companies in an internationally competitive industry do not exist in isolation Supporting industries form “clusters” of economic activity in the geographic area Each industry reinforces the competitiveness of every other industry in the cluster

32. 5 - 32 Copyright © 2014 Pearson Education, Inc. Firm Strategy, Structure, and Rivalry  Highly skilled managers are essential because strategy has lasting effects on firm competitiveness  Domestic industry whose structure and rivalry create an intense struggle to survive strengthens competitiveness

33. 5 - 33 Copyright © 2014 Pearson Education, Inc. Discussion Question National __________ theory states that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade. a. Product life cycle b. First-mover c. Competitive advantage

34. 5 - 34 Copyright © 2014 Pearson Education, Inc. Answer to Discussion Question National __________ theory states that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade. a. Product life cycle b. First-mover c. Competitive advantage

35. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. Copyright © 2014 Pearson Education, Inc. 5 - 35