international trade.ppt

7/29/2019 International Trade.ppt

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Theories ofInternational Trade


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Importance of International Trade

When an American Buys a Sony TV

International Tourists exchanges Rupee with Euro

What is a Dell PC?Monitors

PCBs

Drivers

Printers

Box builds

Europe, Asia, (Philips, Nokia, Samsung,

Sony, Acer)

Asia, Scotland, Eastern Europe (SCI,

Celestica)

Asia, Mainly Singapore (Seagate, Maxtor,

Western Digital)

Europe (Barcelona)

Asia, Eastern Europe (Hon Hai / Foxteq)


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Why do countries trade?

Causes for trade:

Availability of products (natural resources, new

products, etc.) International price differential as a consequence

of:

Productivity differential

Differences in technology

Differences in factor endowments

Economies of scale

Product differentiation and market structure


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The Mercantilists View on Trade In the 17th century a group of

men (merchants, bankers, government officials, and

philosophers) wrote essays on international trade that

advocated an economic philosophy known as Mercantilism.

In their view, a country becomes rich if it exports more than it

imports.

The surplus in trade balance will result in an inflow of precious

metals; gold and silver.

The more precious metals means a richer and more powerful

nation.

Countries have to do their best to increase exports and restrict

imports.

Mercantilist's view on trade


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Since all countries cannot have surplus at the same time

and because the stock of metals is fixed in the short run, a

country gains from trade only at the expense of others.

Wealth of nations was measured by the stock of metals

they possess.

In contrast, today we measure wealth of a nation by its

stock of human, man-made, and natural resources availablefor producing goods and services.

Mercantilits advocated strict government control of

economic activity because gain from trade comes at the

expense of other nations (i.e. zero-sum-game).

Mercantilist's view on trade


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Flaws Of Mercantailism

According to Davis Hume, in the Long run,no country could sustain a surplus on the

balance of trade. Government imports restrictions are paid by

consumers in the form of higher taxes.

Government Subsidies of exports of certainindustries are paid by tax payers in form ofhigher taxes.


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Absolute Advantage and the Division

of Labor

Theory first introduced by Adam Smith 1776

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.


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Absolute Advantage Theory

A tailor does not make his own shoes;

He exchanges a suit for shoes

Each nation specialize and exchange

commodities which have absolute advantage.

Both nations will gain from trade.


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India is efficient in growing Cotton, but

inefficient in growing Wheat.

On the other hand, US, is efficient in growingWheat, but inefficient in Cotton.

India has an absolute advantage over US in

the cultivation of Cotton.

India specialize in Cotton and US in Wheat.


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US India

Wheat(Bushels/man

hour)

6 1

Cloth

(Yards/man hour) 4 5

US Exchanges, 6 bushels W = 5 yard C, US gains 1 yard C, or man hour

India Exchanges, 5 yard C = 6 bushels W, India gains 5 bushel W, or 5 man hours

Both countries gain

6W5C


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Comparative Advantage Theory

Followed Smith

David Ricardo: Principles of Political Economy

(1817). If one country is efficient in both products than

other, what happens?

For example, Portugal can produce both wineand cloth cheaper than England

Portugal has an absolute advantage in both

Opportunity Cost


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David Ricardo showed that such a countrymay still derive benefits from InternationalTrade.

A country which have absolute advantage inproduction of all goods can specialize in theproduction of those goods that the country

produces most efficiently & buy those goodsthat it produces less efficiently from othercountries.


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Labour Cost of production (in hours)

1 Unit of Wine 1 Unit of Cloth

Portugal 80 90

England 120 100


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If no trade, in England

120 hours = 1 W 100 hours = 1 C

1 wine will cost 120/100 or 1.2 cloth

Comparative Advantage Theory:

Gains from Trade


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Gains from Trade

In Portugal

80 hours = 1 W

90 hours = 1 C 1 wine will cost 80/90 or 0.89 cloth


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Gains from Trade

Opportunity Cost of production

1 Unit of Wine 1 Unit of Cloth

Portugal 80/90 = 8/9 90/80 = 9/8

England 120/100 = 12/10 100/120 = 10/12


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Gains from Trade

In Portugal, 1 wine will cost 80/90 or 0.89 cloth If Portugal could import more than 0.89 units of cloth in

exchange of 1 unit of wine, she would gain.

0.83

1.13


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Gains from Trade

In England,1 wine will cost 120/100 or 1.2 cloth Portugal can export 1 unit of wine to England and get an

exchange between 0.89 1.2 cloth

1.13

0.83


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Gains from Trade

In international market, if1Wine exchanges for1 cloth,

advantageous for England. England export cloth and import wine, because, in the

absence of trade, she has to give up 1.2 Cloth for 1 Wine

and save 0.2 cloth.

1.13

0.83


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Gains from Trade

Without trade, Portugal has to give up 1.13 wine to get 1unit cloth. Portugal export wine and import cloth.

Now she can make 1 Wine by 80 hours of labourandexchange 1Wine for 1Cloth.

Save 10 labour.

Both nations gains from trade than isolation

1.13

0.83


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A country that is relatively labor abundant should

specialize in the production of relatively labor-

intensive goods.

It should then export that labor intensive good in

exchange for capital-intensive goods.

A country that is relatively capital abundant should

specialize in the production of relatively capital-intensive goods.

It should then export it in exchange for labor-intensive

goods.

Heckscher (1919)Ohlin(1933) Trade Model

(Factor Proportion Theory)


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Heckscher-Ohlin Trade Model


According to Heckscher and Ohlin, Factor

Endowment (types of resources) varies from

country to country. Goods differ according to the types of factors

that are used to produce them.

Difference in factor endowment leads todifference in factor costs.


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One unit of Good X is produced with 4 units of labor

and 1 unit of capital . Since it requires more units of

labor, it is classified as a labor intensive good. On the other hand to produce one unit of Good Y 2

units of labour and 4 units of capital are required.

Since it uses more amount of capital when compared

to Good X, it is called as capital intensive good. Example: Leather goods are labor intensive while

computer chips are capital intensive.




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According to HO Theory, A country will havea comparative advantage in producingproducts that intensively use resources

(factors of production) it has in abundance. Ex: Saudi Arabia-abundance of crude oil

reserves

India - abundance of unskilled labour US abundance of capital

China abundance of labour

Australia & Canada abundance of land


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Leontief Paradox (1953)

Wassily Leontief (1950) Tested the Factor Proportions

theory on goods imported and exported by the United

States. Leontief reached a paradoxical conclusion thatthe USthe most capital abundant country in the world

by any criterionexported labor-intensive commodities

and imported capital- intensive commodities.

Input-Output Analysis: A method for estimating marketactivities. Considered potential that measures the factor

inflows into production and the resultant outflow of

products.


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Product Life-Cycle Theory

(Raymond Vernon, 1966)

Article in the Quarterly Journal of Economics.

As products mature, both location of sales and optimal

production changes. Affects the direction and flow of imports and exports.

Most appropriate for technology-based products.

Most relevant to products that eventually fall victim tomass production.

Globalization and integration of the economy makes this

theory less valid.


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There are 4 stages in Product Life cycle:-

Introductory Stage

Maturing Stage

Standardized product Stage

Declining Stage

Product Life Cycle Theory


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INTRODUCTORY STAGE:-

Also known as Innovation stage.

In this stage, A firm develops & introduces aninnovative product.

Early production generally occurs in the domestic

market.

Better to keep production facilities close to themarkets & to the centre of decision making.

Companies may sell a small part of their production

in foreign markets Exports



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MATURING STAGE:-

In this stage, Demand of product expands

domestically & abroad. Domestic production reaches its peak

Foreign competitors expands productivecapacity.

Set up production unit in host country tominimize distribution costInternationalization of Production.



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STANDARDIZED PRODUCT STAGE:- In this stage, Product become more standardized

& prices becomes the main competitive weapon. Production techniques are no longer exclusive &

innovative.

Stiff competition from home as well as other

developed countries. Domestic production slumps.


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Product Life-Cycle Theory160

140

120

10080

60

40

20

0

United States

Other Advanced Countries

Developing Countries

Stages of Production Development

New Product Standardized ProductMaturing Product

Imports

Imports

Exports

Exports

Imports

160

140

120

100

8060

40

20

0

160

140

120

100

8060

40

20

0

Exports

production

consumption


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New Trade Theory

Imperfect Markets and Trade Theory

Paul Krugman

Economics of Scale

Internal Economies of Scale (the cost per unit

depends on size of the individual firm)

External Economies of Scale(the cost per unitdepends on the size of the industry, not the firm)


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Internal and External Economies of

Scale

Internal Economies of Scale:

When a company reduces costs and increases production,

internal economies of scale have been achieved.

External Economies of Scale:

External economies of scale occur outside of a firm, within an

industry. Thus, when an industry's scope of operations

expands due to, for example, the creation of a bettertransportation network, resulting in a subsequent decrease

in cost for a company working within that industry, external

economies of scale are said to have been achieved. With

external ES, all firms within the industry will benefit.


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New Trade Theory

A firm possessing internal economies of scale can

monopolize an industry (creating an imperfect

market) - produce more products, lower and setmarket 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 its

product line.


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New Trade Theory

Began to be recognized in the 1970s.

Deals with the returns on specialization where

substantial economies of scale are present. Specialization increases output, ability to

enhance economies of scale increase.

In addition to economies of scale, learning effects

also exist.

Learning effects are cost savings that come from

learning by doing.


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Application of the New Trade Theory

Typically, requires industries with high, fixed costs.

World demand will support few competitors.

Competitors may emerge because they got therefirst.

First-mover advantage.

Economies of scale may preclude new entrants.

Some argue that it generates government intervention

and strategic trade policy.


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Porters Diamond(Harvard Business School, 1990)

The Competitive Advantage of Nations.

Looked at 100 industries in 10 nations.

Thought existing theories didnt go far enough.

Question: Why does a nation achieve international

success in a particular industry?


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Porters DiamondDeterminants of National Competitive Advantage

Factor Endowments

Firm Strategy,

Structure and

Rivalry

Demand Conditions

Related and

Supporting

Industries

Porter claims that four kinds of variables will impact a local firms ability to use acountr s resources to ain a com etitive advanta e


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FACTOR CONDITIONS:-

Porter differentiated between Basic factors &Advanced factors.

Basic Factors: Land, Labor, Capital, Naturalresources, etc.

Advanced Factors: Technology, Infrastructure,Education level of work force.

Porter said, Favorable Factor conditions leadsto favorable competitive conditions in themarkets.



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DEMAND CONDITIONS:

This represents the Consumer Demand,

If the consumers are well aware then the firm hasto develop high quality product & firm can

compete internationally with good quality

product & vice versa.



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RELATED & SUPPORTING INDUSTRY:-

These are the industries which gives input to the

firms & have spill over effect. If the input produced by supporting Industry is

superior i.e. of good quality, then the final

product is also of good quality & the firm can

compete internationally.



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FIRMS STRATEGY, STRUCTURE &RIVALRY:-

Different Countries have different ideologies. The more is the rivalry, the more pressure to

produce good product & firm can competeinternationally with good quality product.

Therefore, Rivalry is important to develop worldclass product.



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Thank you.

international trade.ppt

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