international trade theories for ib

8/10/2019 International Trade Theories for IB

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Presentation onTrade Theories for International

BusinessRupali Dhavale (A)(06)

Ajay Jain (A)(11)Bhagyashree Lad (A)(16)Jeevitha Reddy (A)(25)Naina Mahavar (B)(06)

Jyoti Jadhav (B)(07)

Nachiekaet Khaadey(B)(11)Pranav Mahaddalkar(B)(12)Hemanshu Patel (B)(23)

Dipesh Rao (B)(27) Aakanksha Surve (B)(39)


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International TradeInternational trade is the exchange of goods and

services between countries

Trading globally gives consumers and countries the

opportunity to be exposed to goods and services

not available in their own countries


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Significance of International Trade

A country may import things which it cannot

produce

Maximum utilization of resources

Benefit to consumer

Reduces trade fluctuations

Utilization of Surplus produce

More employment could be generated

Promotes efficiency in production


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International Trade Theories

1960

1970

1980

1990

2000

1914-1918

1939-1945

WW1

WW2

Industrialrevolution

Mercantilism

Absoluteadvantage

Comparativeadvantage

New TradeTheory

Nationalcompetitiveadvantage

Product lifecycle


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1) Comparative Advantage Theory

A famous economist namedDavid Ricardo (1772-1823)came up with the law ofcomparative advantage.

According to this law,specialization and free tradebenefits all trading partners.

Countries should specializein those goods they have acomparative advantage in.


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Cont.The country should import the goods itproduces less efficiently, even if it can producethat good all by itself.Due to increased efficiency (better use oflimited resources), potential world production isgreater with unrestricted free trade.Comparative Advantage maximize countriescombined output

A country has a comparative advantage if itcan produce something at a lower cost thanothers


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Underlying Assumptions ofComparative Advantage

Ricardo explains his theory with the help of followingassumptions :-

There are two countries and two commoditiesLabor is the only factor of production other thannatural resourcesLabor is perfectly mobile within a country butperfectly immobile between countriesThere is no technological changeTrade between two countries takes place on bartersystemThere is no transport cost


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What determines comparativeadvantage?

The quantity and quality of factors of production

available

Investment in research & development

Movements in the exchange rate

Long-term rates of inflation

Import controls such as tariffs and quotas

Non-price competitiveness of producers


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Merits of Comparative AdvantageTheory

International trade is possible even when a country

is able to produce all goods at cheaper cost

The country can produce more of those goods than

it needs and export them to other countries

Total production of goods will be increased

Country could increase its income


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Demerits of Comparative AdvantageTheory

Transport costs may outweigh any comparative

advantage

Increased specialization may lead to diseconomies

of scale

Governments may restrict trade

Comparative advantage measures staticadvantage but not any dynamic advantage


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2) Competitive Advantage Theory

Economist Michael Porter, firstdefined national competitiveadvantage (NCA) in his 1990book The Competitive

Advantage of Nations NCA is basically an evaluationof how competitively a nationparticipates in international

markets The two types of competitiveadvantage an organization canachieve relative to its rivals:lower cost or differentiation.


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Competitive advantage strategies


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Porters Stages ofNational Competitive Development

There are 4 drivers of Development

1) Factor Condition

2) Investment

3) Innovation

4) Wealth


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Forces Influencing Competitiveness

The model of the Five Competitive Forces wasdeveloped by Michael E. Porter in his bookCompetitive Strategy: Techniques for AnalysingIndustries and Competitors in 1980.


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IKEA


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COCO-COLA


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McDonald.


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Porters Diamond-Shaped Framework


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Factor Conditions For example, Japan is a small nation that lacksenough land fit for agriculture; in order to make upfor this and become more competitive in theinternational markets, however, Japan has

exploited its wealth of human resources to becomea global leader in technology.


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Demand Conditions For example, if there is a high demand for theiPhone in the U.S., Apple will be more willing towork on improving its design and thus do better innot only the U.S. market, but the international

market as well.


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Related and Supporting Industries

For example, the success of the automobileindustry not only benefits the industries of itssuppliers (e.g. metal, leather, rubber), but alsoindustries that are directly linked to automobiles

(e.g. car insurance).


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Firm Strategy, Structure, and Rivalry

For example, the rivalry between iPhones and Androids in the Smartphone market is healthybecause this incites innovation on either side andmakes both companies key players in providing the

U.S. with a high-ranking NCA.


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Purchasing power parity

Is a real value comparison between twocurrencies

It means we should able to purchase sameamount of goods in either country

A bundle of goods should cost the same invarious countries


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Example:

Product: Baseball Bat1 $ = 60 Rs

India US

600 Rs 40 $

Convert Rs to $1 $ 60 Rs

10$ 600Rs

Difference in cost = 30 $(40 $ - 10$)


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Price was less In India

Quantity demanded Cost of Product Value of Rs

1 $ = 50 Rs

India US1500 Rs 30 $

Convert Rs to $1 $ 50 Rs

30$ 1500Rs

Difference in cost = 0 $(30 $ - 30$)


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Purchasing Power Parity and the Long Run

Price differentials between countries are notsustainable in the long run

An individual or company will be able to gain

an arbitrage profit by buying the good cheaply in onemarket and selling it for a higher price in the othermarket


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Two Views of PPP

Absolute Purchasing Power Parity

Relative Purchasing Power Parity


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Absolute Purchasing Power Parity Exchange rate between two countries will be identical to

the ratio of the price levels for those two countries.

This concept is derived from a basic idea known as thelaw of one price, which states that the real price of agood must be the same across all countries.

The following conditions must be met for this relationshipto be true: The goods of each country must be freely tradable

on the international market.

The price index for each of the two countries must becomprised of the same basket of goods.

All of the prices need to be indexed to the same year.


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Formula S= P P * Where,

S is the spot exchange rate between two countries(the rate of the amount of foreign currency neededto trade for the domestic currency).

P is the price index for a domestic country.

P * is the price index for a foreign country.


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Example:

Soybeans are currently priced at $5 a bushel inthe U.S., that soybeans are priced at 5.50 perbushel inEurope, and that the exchange rate is

1.10 euros per dollar. Suppose that the price ofsoybeans goes up to 6.05 per bushel (a 10%increase) in Europe, while the price of soybeans inthe U.S. only goes up on 5%, to $5.25 a bushel. Ifthere is no depreciation in the euro to offset the 5%difference, then European soybeans will not becompetitive on the international market and tradeflowing from the U.S. to Europe will greatlyincrease.


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Problems with Absolute PPP Absolute PPP may not hold due to:

Transportation costs and tariffs are present.

National price indexes capture the prices of goodsthat are not traded internationally.

Changes in the exchange rate may be due to realrather than nominal economic events. Real events,such as relative price changes resulting from a poorharvest, may cause deviations from absolute PPPas the exchange rate changes, even if the price

indexes remain constant.


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Relative Purchasing Power Parity

Relative PPP states there is a correlation betweenprice-level changes between two countries andcurrency exchange rates.

Relative PPP maintains that though the price forthe same item varies in different countries, thepercentage of the difference is relatively the sameover a longer period.

The percentage of appreciation or depreciation ofcurrencies is equal to the percentage differencebetween the two country's inflation rates.


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Formula S 1 / S 0 = (1 + I y) (1 + I x)

Where,S 0 is the spot exchange rate at the beginning of the timeperiod (measured as the "y" country price of one unit ofcurrency x)

S 1 is the spot exchange rate at the end of the timeperiod.

Iy is the expected annualized inflation rate for country y,which is considered to be the foreign country.

Ix is the expected annualized inflation rate for country x,

which is considered to be the domestic country.


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ExampleEx 1: Suppose that the annual inflation rate is expected tobe 8% in the Eurozone and 2% in the U.S. The current

exchange rate is $1.20 per euro (1.00 = $1.20). Whatwould the expected spot exchange rate be in sixmonths for the euro?

Ex 2: Assume that the U.S. is the foreign country andthat Japan is the domestic country. The current spot

exchange rate is S 0 = 115 yen per dollar ($1 per 115.00). The expected annual inflation rate forthe U.S. is 4.89%, and the annual expected Japaneseinflation rate is 6.23%. Compute the approximateexpected spot rate and the expected spot rate one yearfrom now.


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4) Product Life Cycle Theory

The product life-cycletheory is an economic

theory that was developed

by Raymond Vernon

After the product becomes

adopted and used in the

world markets, production

gradually moves away

from the point of origin


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Stages of Product LifeCycle


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Stages of Product LifeCycle1) Introduction

New product launched on the marketLow level of salesLow capacity utilizationUsually negative cash flowHeavy promotion to make consumersaware of the product


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Stages of Product LifeCycle2) Growth Cash flow may become positive The market grows, profits rise but

attracts the entry of new competitors Advertising to promote brand

awareness Increase in distribution outlets Improve the product - new features,

improved styling, more options


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Stages of Product LifeCycle3) Maturity

High profits for those with high marketshare

Cash flow should be strongly positiveWeaker competitors start to leave themarketSlower sales growth as rivals enter themarketPrices and profits fall


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Stages of Product LifeCycle4) Decline

Falling salesMarket saturation and/or competitionDecline in profits & weaker cash flowsMore competitors leave the marketDecline in capacity utilization


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International changes during aProduct Life Cycle

Introduction Growth Maturity Decline

3)Competitive Factors

Nearmonopolyposition

Salesbased onuniquenessrather thanprice

EvolvingproductCharacteristics

Fastgrowingdemand

Number ofcompetitor s increase

SomeCompetitor s beingprice-cutting

ProductbecomingmoreStandardiz

e

Overallstabilize

Number ofcompetitorsdecrease

Price isveryimportantespeciallyin LDCs

Overalldeclinedemand

Price is akeyweapon

NumberofProducerContinues todecrease


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International changes during aProduct Life Cycle

Introduction Growth Maturity Decline

4)ProductionTechnolog

y

ShortProductionrun

Evolvingmethods tocoincidewith productevolution

High labor

and laborskillsrelative tocapital input

Capitalinputincreases

Methodsare morestandardize

Longproductionrun using

highcapitalincome

Highlystandardize

Less laborskillneeded

Unskilledlabor onmechaniz

ed longrunproduction


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Things Needed for InternationalProduct Life Cycle1) The structure of the demand for the

product2) Manufacturing3) International competition

and marketing strategy4) The marketing strategy of the

company that invented or innovatedthe product

St f th i iti ti


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Stages from the initiatingcountry view point

ProductStage Trade TargetMarket Competitors ProductionCostLocally

New Limitedproductionfor homemarket

Inventor scountry

few localfirms

Initially high

Mature Increasingexports

Inventor scountry andlaterdevelopingmarkets

competitorsfromadvancedmarkets

Decliningdue toeconomiesof scale

Standardization

Decliningexport atfirst, later inphase

becomeimports

Inventor scountry

Competitorsfrom mostlydevelopingmarkets

Lowereconomiesof scale andcomparative

disadvantages


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Pros of International ProductLife Cycle

The model helps organisations thatare beginning their internationalexpansion

According to Vernon, most managersare myopicThe IPLC model was widely adoptedas the explanation of the waysindustries migrated across bordersover time


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Cons of International ProductLife Cycle

It is difficult to determine the phase ofa product in product life cycles

He used the product side of theproduct life cycle, not the consumerside

Selling older products to a lesserdeveloped market does not work iftransportation costs for imports is low


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Any Questions


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international trade theories for ib

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