Theories of International Business

Theories of International Theories of International BusinessBusiness

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KUSHAGRA SHARMAKUSHAGRA SHARMAksks

Comparative Cost TheoryComparative Cost Theory Opportunity Cost TheoryOpportunity Cost Theory Factor Endowment TheoryFactor Endowment Theory Other…Other…

• Theory of Absolute Different CostTheory of Absolute Different Cost• The Productivity TheoryThe Productivity Theory• The Vent for Surplus TheoryThe Vent for Surplus Theory• Mill’s Theory of Reciprocal DemandMill’s Theory of Reciprocal Demand

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Comparative Cost Theory.....Comparative Cost Theory..... Given by David Recardo in 1817, used two Given by David Recardo in 1817, used two

country, two commodity model.country, two commodity model.

Business b/w 2 countries is profitable when a Business b/w 2 countries is profitable when a country produces a good at lower price than other country produces a good at lower price than other country.country.

One country produces more than one product One country produces more than one product efficiently but one product more efficiently.efficiently but one product more efficiently.

Business b/w 2 nations only when a country Business b/w 2 nations only when a country specializes in the production in which it has specializes in the production in which it has greater efficiency.greater efficiency.

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Comparative Cost Theory.....Comparative Cost Theory.....

The factors offering this advantage are: The factors offering this advantage are: • cheap &/or skilled labour,cheap &/or skilled labour,• advanced technology,advanced technology,• qualitative raw material,qualitative raw material,• competent mgmt practices, etc.competent mgmt practices, etc.

For Ex:…For Ex:…• Japan has advantage in producing electronic Japan has advantage in producing electronic

items at low cost whereas India has an items at low cost whereas India has an advantage in textiles.advantage in textiles.

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Comparative Cost Theory.....Comparative Cost Theory..... Assumptions:Assumptions:

• Only element of cost of production is ‘Labour’Only element of cost of production is ‘Labour’• No Trade BarriersNo Trade Barriers• No Transportation CostNo Transportation Cost

Derivations:Derivations:• Efficient allocation of global resourcesEfficient allocation of global resources• Almost equal product prices in world market.Almost equal product prices in world market.• Demand optimization of products Demand optimization of products

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Opportunity Cost Theory…Opportunity Cost Theory…

Proposed by Gottfried Haberler 1959Proposed by Gottfried Haberler 1959 Opportunity cost is the value of Opportunity cost is the value of

alternatives which have to be alternatives which have to be foregone in order to obtain another foregone in order to obtain another particular thing.particular thing.• For ex: Rs. 1000 invested in equity & For ex: Rs. 1000 invested in equity &

earned 6%. The opportunity cost of this earned 6%. The opportunity cost of this investment is 10% interest if deposited investment is 10% interest if deposited in bank for 1 year.in bank for 1 year.

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Opportunity Cost Theory…Opportunity Cost Theory…

Specifies the cost in terms of the Specifies the cost in terms of the value of the alternatives which have value of the alternatives which have to be foregone in order to fulfill a to be foregone in order to fulfill a specific act.specific act.

Provides the basis for international Provides the basis for international business of exporting a product to a business of exporting a product to a particular country rather than to particular country rather than to another country.another country.

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Factor Endowment Theory…Factor Endowment Theory…

Bertil Ohlin & Eli HeckscherBertil Ohlin & Eli Heckscher Explains the reasons of comparative Explains the reasons of comparative

cost differences.cost differences. A country will specialize in the A country will specialize in the

production & export of those goods production & export of those goods whose ratio b/w capital & other whose ratio b/w capital & other factors of production is higher than factors of production is higher than those in other countries.those in other countries.• For ex: Crude Oil in Gulf CountriesFor ex: Crude Oil in Gulf Countries

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Factor Endowment Theory…Factor Endowment Theory…

Assumptions:Assumptions:• Free TradeFree Trade• No Transportation costNo Transportation cost• Factor of production vary from country Factor of production vary from country

to countryto country• Other factors of production are of equal Other factors of production are of equal

quality & perfectly mobile between the quality & perfectly mobile between the countries.countries.

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Factor Endowment Theory…Factor Endowment Theory…

Merits:Merits:• Superior than Comparative Cost Theory Superior than Comparative Cost Theory

as it provide basis for differentiation in as it provide basis for differentiation in cost of production.cost of production.

• Provides more valid basis for the Provides more valid basis for the existence of international business than existence of international business than other theories.other theories.

• Indicates the impact of international Indicates the impact of international business on product & factor prices.business on product & factor prices.

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Other Theories…Other Theories…

Theory of Absolute Different Cost:Theory of Absolute Different Cost:• Adam SmithAdam Smith• produce only those products which they produce only those products which they

can produce at lowest price and can produce at lowest price and exchange them with the products of exchange them with the products of other countries produced at lowest other countries produced at lowest prices.prices.

• Criticism:Criticism: Most of the developing countries are unable Most of the developing countries are unable

to produce googds at lowest cost.to produce googds at lowest cost.

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Other Theories…Other Theories…

The Productivity Theory:The Productivity Theory:• Emphasizes on adapting & reshaping Emphasizes on adapting & reshaping

production structure of a trading country production structure of a trading country to meet the export demands.to meet the export demands.

• Encourages the developing countries to Encourages the developing countries to go for cash crops & adapting latest go for cash crops & adapting latest technology.technology.

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Limitations of Productivity Theory…Limitations of Productivity Theory…

Labour productivity do not increase Labour productivity do not increase after certain level.after certain level.

Increase in working hours to meet Increase in working hours to meet export demands.export demands.

Limited skilled labour.Limited skilled labour.

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Other Theories…Other Theories…

The Vent for Surplus Theory…The Vent for Surplus Theory…• If the countries produce more than If the countries produce more than

domestic demand, they have to export domestic demand, they have to export the surplus to other countries. This the surplus to other countries. This surplus gives the benefits under surplus gives the benefits under international trade.international trade.

• Also known as “Surviving Relic of the Also known as “Surviving Relic of the Mercantile Theory (J.S. Mill)”Mercantile Theory (J.S. Mill)”

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Other Theories…Other Theories…

Mill’s theory of Reciprocal Demand…Mill’s theory of Reciprocal Demand…• Indicates a country’s demand for a Indicates a country’s demand for a

commodity in terms of other commodity in terms of other commodity, it is prepared to give in commodity, it is prepared to give in exchange.exchange.

• Reciprocal demand determine the term Reciprocal demand determine the term of trade & relative share of each of trade & relative share of each country.country.

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