INTERNATIONAL TRADE

AND INVESTMENT THEORY

COLLEGE OF AGRIBUSINESS MANAGEMENT

PANTNAGAR
 ABSOLUTE ADVANTAGE


Export those goods and services for which a country is
more productive than other countries


Import those goods and services for which other

countries are more productive than it is
 Australia has more agricultural land
but less labor, and capital, and mines
than Great
3 Britain; consequently,
Australia is better adapted to the
production of goods that require great
quantities of agricultural land,
whereas Great Britain has an
advantage in the production of goods
requiring considerable quantities of
other factors.

Australia vs Great
Britain
MUTUAL ABSOLUTE ADVANTAGE

YIELD PER ACRE OF WHEAT AND COTTON

INDIA BANGLADESH
Wheat 6 MT 2 MT
Cotton 2 MT 6 MT

•In this example, India can produce three times the wheat that Bangladesh
can on one acre of land, and Bangladesh can produce three times the
cotton. We say that the two countries have mutual absolute advantage.
 MUTUAL ABSOLUTE ADVANTAGE

•Suppose that each country divides its land to obtain equal units of cotton
and wheat production.

TOTAL PRODUCTION OF WHEAT AND COTTON ASSUMING

NO TRADE, MUTUAL
INDIAABSOLUTE ADVANTAGE,
BANGLADESH AND 100
AVAILABLE
Wheat ACRES
25 acres x 6 MT/acre 75 acres x 2 MT/acre
150 MT 150 MT
Cotton 75 acres x 2 MT/acre 25 acres x 6 MT/acre
150 MT 150 MT
 GAINS FROM SPECIALIZATION

 An agreement to trade 300 MT of wheat for 300 MT

of cotton would double both wheat and cotton
consumption in both countries.

PRODUCTION AND CONSUMPTION OF WHEAT

AFTER SPECIALIZATION
PRODUCTION CONSUMPTION
India Bangladesh India Bangladesh

Wheat 100 acres x 6 MT/acre 0 acres 300 MT 300 MT

600 MT 0
Cotton 0 acres 100 acres x 6 MT/acre 300 MT 300 MT
0 600 MT
 PRODUCTION POSSIBILITY FRONTIERS FOR
BANGLADESH AND INDIA BEFORE TRADE

Bangladesh India

 Because both countries have an absolute advantage in

the production of one product, specialization and
trade will benefit both.
GAINS FROM SPECIALIZATION

Bangladesh India
 COMPARATIVE ADVANTAGE


Produce and export those goods and services for
which it is relatively more productive than other
countries

Import those goods and services for which other
countries are relatively more productive than it is
COMPARATIVE ADVANTAGE WITH MONEY

One is better off specializing in what one

does relatively best

Produce and export those goods and services
one is relatively best able to produce

Buy other goods and services from people
who are better at producing them
GAINS FROM COMPARATIVE ADVANTAGE

MT MT
MT MT

INDIA INDIA

BANGLADESH BANGLADESH

INDIA BANGLADES
H
GAINS FROM COMPARATIVE ADVANTAGE

 To illustrate the gains from comparative advantage,

assume (again) that in each country people want to
consume equal amounts of cotton and wheat.
Now, each country is constrained by its domestic
production possibilities curve, as follows:

YIELD PER ACRE OF WHEAT AND COTTON

India Bangladesh
Wheat 6 MT 1 MT
Cotton 6 MT 3 MT
GAINS FROM COMPARATIVE ADVANTAGE

TOTAL PRODUCTION OF WHEAT AND COTTON ASSUMING

NO TRADE AND India
100 AVAILABLE ACRES
Bangladesh
Wheat 50 acres x 6 MT/acre 75 acres x 1 MT/acre
300 MT 75 MT
Cotton 50 acres x 6 MT/acre 25 acres x 3 MT/acre
300 MT 75 MT

 The gains from trade in this example can be

demonstrated in three stages.
GAINS FROM COMPARATIVE ADVANTAGE

 Stage 1: Bangladesh transfers all its land into cotton

production. India cannot completely specialize in
wheat because it needs 300 MT of cotton and will
not be able to get enough cotton from Bangladesh
(if countries are to consume equal amounts of
cotton and wheat).
REALIZING A GAIN FROM TRADE WHEN ONE COUNTRY
HAS A DOUBLE STAGE
ABSOLUTE
1 ADVANTAGE
India Bangladesh
Wheat 50 acres x 6 MT/acre 0 acres
300 MT 0
Cotton 50 acres x 6 MT/acre 100 acres x 3 MT/acre
300 MT 300 MT
GAINS FROM COMPARATIVE ADVANTAGE

 Stage 2: India transfers 25 acres out of cotton and

into wheat.

REALIZING A GAIN FROM TRADE WHEN ONE COUNTRY

HAS A DOUBLE STAGE
ABSOLUTE
2 ADVANTAGE
India Bangladesh
Wheat 75 acres x 6 MT/acre 0 acres
450 MT 0
Cotton 25 acres x 6 MT/acre 100 acres x 3 MT/acre
150 MT 300 MT
GAINS FROM COMPARATIVE ADVANTAGE

Stage 3: Countries trade

REALIZING A GAIN FROM TRADE WHEN ONE COUNTRY
HAS A DOUBLE STAGE
ABSOLUTE
3 ADVANTAGE
India Bangladesh
100 MT (trade)
Wheat 350 MT 100 MT
(after trade)
200 MT (trade)

Cotton 350 MT 100 MT

(after trade)
 DIFFERENCES BETWEEN COMPARATIVE AND
ABSOLUTE ADVANTAGE

A country enjoys an absolute advantage over

another country in the production of a product if it
uses fewer resources to produce that product than
the other country does.


A country enjoys a comparative advantage in the

production of a good if that good can be produced at
a lower cost in terms of other goods.



 ABSOLUTE ADVANTAGE VERSUS COMPARATIVE
ADVANTAGE


Absolute versus relative productivity differences

Comparative advantage incorporates the concept of
opportunity cost

 GAINS FROM COMPARATIVE ADVANTAGE

Even if a country had a considerable absolute

advantage in the production of both goods, then
specialization and trade are still mutually
beneficial.

When countries specialize in producing the goods in
which they have a comparative advantage, they
maximize their combined output and allocate their
resources more efficiently.
GAINS FROM COMPARATIVE ADVANTAGE

The real cost of producing cotton is the wheat that

must be sacrificed to produce it.

A country has a comparative advantage in cotton
production if its opportunity cost, in terms of
wheat, is lower than the other country.
FACTOR ENDOWMENT THEORY

Comparative advantage is explained by factor

endowments. Trade takes place because of
differences in factor endowments.

Nations export products that use inputs which are
relatively abundant (cheap) at home, and import
products which need inputs which are relatively
scarce (expensive) at home.

 HOW DOES A COUNTRY DIFFERENTIATE
FROM ANOTHER?

ß There should be some kind of natural distinction between

regions.
ß
ßThe principal criterion used to differentiate one region
from another is its endowment with factors of
production.
ß
ßHence, regions have different factor endowments, while
the factors within a region are essentially similar.
 ASSUMPTIONS

Two countries, two goods & two factors

One good labor intensive & the other capital
intensive
Same technology
Same taste (same indifference curves)
Incomplete specialization
Constant returns to scale
Perfect competition in both goods & factor markets
Factors mobile domestically but not internationally
No transportation costs or restrictions on trade
 FACTOR ENDOWMENT THEORY: IMPLICATIONS

Factor price equalization

 The shift within each nation towards use of cheaper factors,
and away from expensive ones, leads to more equal factor
prices (if factors are mobile)

Distribution of income
 Trade changes domestic distribution of income as demand for
different factors changes

Tests of factor endowment theory
 Emphasize the importance of varieties of different factors
(such as human capital) and accounting for changes in
resource endowment; other explanations are also important
 SOME COMMENTS ON
FACTOR ENDOWMENT THEORY

Factor endowment theory breaks away from the

classical labor value theory and tries to explain the
reason of international trade in an entirely new way.
Heckscher-Ohlin theory holds that comparative
advantages enjoyed by different countries are the pre-
requisite of trade. These comparative advantages,
however, do not come from the relative differences in
labor inputs of production as the classical economists
described.
It is the differences in a country’s production factor
endowment that determines the production costs of
different countries and thus their respective
comparative advantages in international trade.
PRODUCT LIFE CYCLES & OTHER THEORIES OF
INTERNATIONAL BUSINESS

 The Product Life Cycle (PLC) is based upon the biological life cycle.
For example, a seed is planted (introduction); it begins to sprout
(growth); it shoots out leaves and puts down roots as it becomes an
adult (maturity); after a long period as an adult the plant begins to
shrink and die out (decline).

 In theory it's the same for a product. After a period of development it is
introduced or launched into the market; it gains more and more
customers as it grows; eventually the market stabilizes and the
product becomes mature; then after a period of time the product is
overtaken by development and the introduction of superior
competitors, it goes into decline and is eventually withdrawn.
 The Product Life Cycle (PLC)

 However, most products fail in the introduction phase.

Others have very cyclical maturity phases where declines
see the product promoted to regain customers.

 The Product Life Cycle (PLC)

 Introduction.
 The need for immediate profit is not a pressure. The
product is promoted to create awareness. If the product has
no or few competitors, a skimming price strategy is
employed. Limited numbers of product are available in few
channels of distribution.
 Growth.
 Competitors are attracted into the market with very
similar offerings. Products become more profitable and
companies form alliances, joint ventures and take each other
over. Advertising spend is high and focuses upon building
brand. Market share tends to stabilise.
 The Product Life Cycle (PLC)

Maturity.
 Those products that survive the earlier stages
tend to spend longest in this phase. Sales grow at a
decreasing rate and then stabilize. Producers
attempt to differentiate products and brands are key
to this. Price wars and intense competition occur. At
this point the market reaches saturation. Producers
begin to leave the market due to poor margins.
Promotion becomes more widespread and use a
greater variety of media.
 The Product Life Cycle (PLC)

Decline.
 At this point there is a downturn in the market.
For example more innovative products are introduced
or consumer tastes have changed. There is intense
price-cutting and many more products are withdrawn
from the market. Profits can be improved by reducing
marketing spend and cost cutting.
 Product Life-Cycle Theory

 The product life-cycle theory is an economic theory that was

developed by Raymond Vernon in response to the failure of the
Heckscher-Ohlin model to explain the observed pattern of
international trade. The theory suggests that early in a
product's life-cycle all the parts and labor associated with that
product come from the area in which it was invented. After the
product becomes adopted and used in the world markets,
production gradually moves away from the point of origin. In
some situations, the product becomes an item that is imported
by its original country of invention.
The International Product Life Cycle:
Innovating Firm’s Country
The International Product Life Cycle: Other
Industrialized Countries
The International Product Life Cycle: Less
Developed Countries