Copyright @ Oxford University Press Copyright @ Oxford University Press International Business R. M. International Business R. M. Joshi Joshi 1 THEORIES OF THEORIES OF INTERNATIONAL INTERNATIONAL TRADE TRADE C2
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THEORIES OF THEORIES OF INTERNATIONAL INTERNATIONAL
TRADETRADE
C2
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Learning ObjectivesLearning Objectives
To discuss the implications of trade theories on To discuss the implications of trade theories on international businessinternational business
To explain various theories of international trade To explain various theories of international trade To examine gains from trade under various trade To examine gains from trade under various trade
theoriestheories To explain the theoretical framework for shifting To explain the theoretical framework for shifting
patterns of production and tradepatterns of production and trade
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Implications of Trade Theories
Trade theories provides the conceptual base for international trade
and shifts in trade patterns. They also facilitate in understanding the
basic reasons behind the evolution of a country as a supply base or
market for specific products.
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Theory of MercantilismTheory of Mercantilism
The theory attributes and measures the wealth of a The theory attributes and measures the wealth of a
nation by the size of its accumulated treasures. It aims nation by the size of its accumulated treasures. It aims
at accumulating financial wealth in terms of gold by at accumulating financial wealth in terms of gold by
encouraging exports and discouraging imports.encouraging exports and discouraging imports.
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Theory of Absolute AdvantageTheory of Absolute Advantage
Absolute advantageAbsolute advantage may be defined as ability of a nation to produce the goods may be defined as ability of a nation to produce the goods
more efficiently and cost effectively than any other country. more efficiently and cost effectively than any other country.
According to the theory, each country should specialize in producing those According to the theory, each country should specialize in producing those
goods that it can produce more efficiently, instead of producing all products. goods that it can produce more efficiently, instead of producing all products.
Thus, a country should use increased production to export and acquire more Thus, a country should use increased production to export and acquire more
goods by way of imports which in turn would improve living standards of its goods by way of imports which in turn would improve living standards of its
people.people.
Absolute Advantage- Resources required to produce 1 ton of Cocoa and RiceAbsolute Advantage- Resources required to produce 1 ton of Cocoa and Rice
Ghana -Ghana - 1010 2020 S.KoreaS.Korea 4040 1010With out tradeWith out trade
GhanaGhana 1010 55S.KoreaS.Korea 2.52.5 1010
12.512.5 1515With SpecializationWith SpecializationGhanaGhana 2020 00S.KoreaS.Korea 00 2020
2020 2020After trade 6 tonsAfter trade 6 tons
1414 6666 1414
Increase in consumptionIncrease in consumption44 113.53.5 4.04.0
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Theory of Comparative AdvantageTheory of Comparative Advantage
Comparative AdvantageComparative Advantage may be defined as the inability of a nation to produce a may be defined as the inability of a nation to produce a
good more efficiently than other nations, but its ability to produce that good more good more efficiently than other nations, but its ability to produce that good more
efficiently compared to the other good. efficiently compared to the other good.
Thus, the country may be at an absolute disadvantage with respect to both the Thus, the country may be at an absolute disadvantage with respect to both the
commodities but the absolute disadvantage is lower in one commodity than another. commodities but the absolute disadvantage is lower in one commodity than another.
Therefore, a country should specialize in the production and export of a commodity Therefore, a country should specialize in the production and export of a commodity
in which the absolute disadvantage is less than that of another commodity or in other in which the absolute disadvantage is less than that of another commodity or in other
words, the country has got a comparative advantage in terms of more production words, the country has got a comparative advantage in terms of more production
efficiency.efficiency.
Comparative Advantage- Resources required to produce 1 ton of Cocoa and Comparative Advantage- Resources required to produce 1 ton of Cocoa and RiceRice
Ghana -Ghana - 1010 13.3313.33 S.KoreaS.Korea 4040 2020With out tradeWith out trade
GhanaGhana 1010 7.57.5S.KoreaS.Korea 2.52.5 55
12.512.5 12.512.5With SpecializationWith SpecializationGhanaGhana 1515 3.753.75S.KoreaS.Korea 00 1010
1515 13.7513.75After trade 4 tonsAfter trade 4 tons
1111 7.757.7544 66
Increase in consumptionIncrease in consumption11 .25.251.51.5 1.01.0
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Revealed Comparative AdvantageRevealed Comparative Advantage
It is measured by a country’s share of world exports of a commodity divided It is measured by a country’s share of world exports of a commodity divided
by its share in total exportsby its share in total exports..
RCARCAij ij = (X= (Xijij/X/Xwjwj)/(X)/(Xi i / X/ Xww))
WhereWhere
XXij ij = i= ith th country’ export of commodity j country’ export of commodity j
XXw w = world exports of commodity j= world exports of commodity j
XXi i = total exports of country i= total exports of country i
XXw w = total world exports= total world exports
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Factor Endowment Factor Endowment (Hecksher-Ohlin) Theory(Hecksher-Ohlin) Theory
Why comparative advantage- Factors of endowments – land, labour, and capital. More Why comparative advantage- Factors of endowments – land, labour, and capital. More
abundant a factor , lower it costs. abundant a factor , lower it costs.
A nation will export the goods whose production requires intensive use of the nation’s A nation will export the goods whose production requires intensive use of the nation’s
relatively abundant and cheap factors and import the goods whose production requires relatively abundant and cheap factors and import the goods whose production requires
intensive use of its scarce and expensive factors.intensive use of its scarce and expensive factors.
US- Sustainable exporters of agricultural goods(Abundance of arable land)US- Sustainable exporters of agricultural goods(Abundance of arable land)
China- Exports goods from labor-intensive manufacturing units- footwear,textile China- Exports goods from labor-intensive manufacturing units- footwear,textile
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The Leontief ParadoxThe Leontief Paradox
Wassily Leontief carried out an empirical test of the Wassily Leontief carried out an empirical test of the
Heckscher-Ohlin Model in 1951 and found that the US Heckscher-Ohlin Model in 1951 and found that the US
exported more labour-intensive commodities and exported more labour-intensive commodities and
imported more capital intensive products which was imported more capital intensive products which was
contrary to the results of Heckscher-Ohlin Model of contrary to the results of Heckscher-Ohlin Model of
factor endowment. factor endowment.
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Country Similarity TheoryCountry Similarity Theory
Trade occurs between nations that have similar Trade occurs between nations that have similar
characteristics, such as economic, geographic, cultural, characteristics, such as economic, geographic, cultural,
etc. However, in case of manufactured goods, cost was etc. However, in case of manufactured goods, cost was
determined by similarity in product demands across determined by similarity in product demands across
countries rather than by relative production costs or countries rather than by relative production costs or
factor endowments factor endowments
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The New Trade TheoryThe New Trade Theory
The theory elucidates that international trade enables a firm The theory elucidates that international trade enables a firm
to increase its output due to specialization by providing to increase its output due to specialization by providing
larger markets, resulting into enhancing its efficiency. It larger markets, resulting into enhancing its efficiency. It
helps explain the trade patterns when markets are not helps explain the trade patterns when markets are not
perfectly competitive or when economies of scale are perfectly competitive or when economies of scale are
achieved by production of specific products. achieved by production of specific products.
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International Product Life Cycle TheoryInternational Product Life Cycle Theory
The theory explains the variations and The theory explains the variations and
reasons for change in production and reasons for change in production and
consumption pattern among various consumption pattern among various
markets over a time period. markets over a time period.
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Stages of International Product Life CycleStages of International Product Life Cycle
The IPLC has four distinct identifiable stages that The IPLC has four distinct identifiable stages that influences demand structure, production, marketing influences demand structure, production, marketing strategy, and international competition as follows: strategy, and international competition as follows: Stage 1: IntroductionStage 1: IntroductionStage 2: GrowthStage 2: GrowthStage 3: MaturityStage 3: MaturityStage 4: DeclineStage 4: Decline
Evaluating the product life cycle theoryEvaluating the product life cycle theory
Product developed- Xerox (1960) in USProduct developed- Xerox (1960) in US Sold initially to US usersSold initially to US users Exported- Japan and Western EuropeExported- Japan and Western Europe As demand grew in these counties- Joint ventures- Japan( Fuji-As demand grew in these counties- Joint ventures- Japan( Fuji-
Xerox), Britain ( Rank-Xerox)Xerox), Britain ( Rank-Xerox) After expiration of patent of Xerox- others countries startedAfter expiration of patent of Xerox- others countries started Like- Canon in Japan, Olivetti in ItlayLike- Canon in Japan, Olivetti in Itlay US export declinedUS export declined US now purchase from lower cost foreign countries- JapanUS now purchase from lower cost foreign countries- Japan Facing high labor cost in Japan- Switched there operations to Facing high labor cost in Japan- Switched there operations to
developing countries- Singapore, Thailanddeveloping countries- Singapore, Thailand Hence- US and Japan- Exporters- ImportersHence- US and Japan- Exporters- Importers
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Theory of Competitive AdvantageTheory of Competitive Advantage
According to the theory, a firm’s home country environment is According to the theory, a firm’s home country environment is
the main source of competencies and innovations often referred the main source of competencies and innovations often referred
to as the diamond mode, it focuses upon the four determinants:to as the diamond mode, it focuses upon the four determinants:
• Factor (Input) ConditionsFactor (Input) Conditions
• Firm Strategy and RivalryFirm Strategy and Rivalry
• Demand ConditionsDemand Conditions
• Related and Supporting IndustriesRelated and Supporting Industries