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Overview
Introduction
An Overview of Trade Theory
The benefits of trade
The pattern of international trade
Trade theory and government policy
Mercantilism
Absolute Advantage
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Overview
Comparative Advantage
Qualifications and assumptions
Extension of the Ricardian Model
Heckscher-Ohlin Theory
The Leontiff Paradox
Overview
The Product Life-Cycle Theory
Evaluating the PLC theory
Overview
National Competitive Advantage: Porters
Diamond
Factor endowments
Demand conditions
Related and supporting industries
Firm strategy, structure, and rivalry
Overview
Evaluating Porters Theory
Implications for Managers
Location
Firstmover advantages
Government policy
Introduction
Refer to the industry of roses of Ecuador; this
product is considered as the Rolls Royce of roses
They have huge heads and unusually vibrant colours,
including 10 different reds
The industry started some 30 years ago and has been
expanding rapidly since
Ecuador is now the worlds fourth largest producer of
roses; it is the nations fifth largest export; $240m in
sales annually
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Introduction
The Ecuadorian rose industry is a striking
example of the benefits of free trade and
globalization
Low barriers to trade have allowed Ecuador to
exploit its comparative advantage in the
growing of roses and thus help the country to
emerge as a major exporter of roses
Economic growth and personal incomes have
been bolstered by the emerging rose industry
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Introduction
Helped consumers in foreign markets to access
affordable high-quality roses from Ecuador
Who are the losers?
Introduction
In the long run, free trade stimulates economic
growth and raises living standards across the
board
International trade theory has shaped the economic
policy of many nations in the past 50 years
It has been the driver in the formation of WTO
and other regional trade blocs; examples?
The 1990s saw a global move toward greater free
trade; why?
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Introduction
It is therefore important to understand what
what these theories are and why they have
been so successful in shaping the economic
policy of so many nations and the
competitive
environment
in
which
international business compete
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Introduction
The aims:
Review the theories that explain why it is
beneficial for a country to engage in
international trade
Explain the pattern of international trade
that we observe in the world economy;
patterns of exports and imports of goods
and services among countries
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Building on Smiths
additional theories
work
are
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two
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Mercantilism
The first theory of international trade; it
emerged in England in the mid-16th century
The principal assertion of mercantilism was
that gold and silver were the mainstays of
national wealth and essential to vigorous
commerce
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Mercantilism
The main tenet
It was in a countrys best interests to
maintain a trade surplus, to export more
than it imported; by doing so, a country
would accumulate gold and silver and,
increase its national wealth, prestige, and
power
English mercantilist writer: Thomas Mun
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Mercantilism
Consistent with this belief, the doctrine advocated
government intervention to achieve a surplus in
the balance of trade; no virtue in large volume of
trade; rather policies to maximise exports and
minimise imports; how?
The classical economist David Hume pointed out
an inherent inconsistency in this mercantilist
doctrine in 1752; example of UK and France
balance of surplus; explain?
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Mercantilism
The flaw with this theory was that it viewed
trade as a zero-sum game; gain by one
country results in a loss by another
Subsequent theories showed the shortsightedness of this approach and
demonstrated that trade is a positive-sum
game, or a situation in which all countries
can benefit
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Mercantilism
Unfortunately, the mercantilist doctrine is
by no means dead
Neo-mercantilists equate political power
with economic power and economic power
with a balance-of-trade surplus
Examples?
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Absolute Advantage
A country has an absolute advantage in the
production of a product when it is more
efficient than any other country in
producing it
Adam Smith attacked the mercantilist
assumption that trade is a zero-sum game;
landmark book of Adam Smith in 1776;
The Wealth of Nations
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Absolute Advantage
Countries differ in their ability to produce goods
efficiently; examples?
According to Smith, countries should specialize in
the production of goods for which they have an
absolute advantage and then trade these for goods
produced by other countries
Example of Ghana and Korea in the production of
cocoa and rice
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Absolute Advantage
Resources required to produce 1 ton of
cocoa and rice
Production and consumption without trade
Production with specialization
Consumption after trade
Increase in consumption as a result of
specialization and trade
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Absolute Advantage
As a result of specialization and trade,
output of different products would increase,
and consumers in various nations would be
able to consume more
Trade is thus a positive sum game; it
produces net gains for all involved
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Comparative Advantage
What happens when one country has an absolute
advantage in the production of all goods?
David Ricardo took Smiths theory one step
further to study the above
Smiths theory of absolute advantage suggests that
a country may not benefit from international trade;
in his book Principles of Political Economy,
Ricardo showed this was not the case
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Comparative Advantage
According to Ricardos theory of
comparative advantage, it makes sense for a
country to specialize in the production of
those goods that it produces most efficiently
and to buy the goods it produces less
efficiently from other countries; even if this
means buying goods from other countries
that it could produce more efficiently itself
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Comparative Advantage
Example of Ghana and Korea in the production of
cocoa and rice; with Ghana having an absolute
advantage in both products; explain?
The basic message of the theory of comparative
advantage is that potential world production is
greater with unrestricted free trade than it is with
restricted trade; consumers in all nations can
consume more if there are no restrictions on trade
This occurs in countries that lack an absolute
advantage in the production of any good
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Comparative Advantage
The theory of comparative advantage
suggests that trade is a positive-sum game
in which all countries that participate
realize economic gains; this theory provides
a strong rationale for free trade
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Comparative Advantage
Qualifications and assumptions
The conclusion that free trade is universally
beneficial is a rather bold; assumptions
made:
Assume a simple world in which there are
only two countries and two goods
Transportation costs?
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Comparative Advantage
Differences in the prices of resources in
different countries; exchange rates?
Resources can move freely from the
production of one good to another
Assume constant returns to scale; there may
may be diminishing or increasing returns to
specialization
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Comparative Advantage
Assume that each country has a fixed stock
of resources and that free trade does not
change the efficiency with which a country
uses its resources
Assume away the effects of trade on income
distribution within a country
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Comparative Advantage
Given these assumptions, can the
conclusion that free trade is mutually
beneficial be extended to the real world of
many countries, many goods, positive
transportation costs, volatile exchange rates,
immobile domestic resources, non-constant
returns to specialization, and dynamic
changes?
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Comparative Advantage
Economists have shown that the basic result
from the simple model can be generalized
to a world of many countries producing
many different goods
However, some economists associated with
the new trade theory, argue that the case, for
unrestricted free trade, while still positive,
loses some of its strength
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Comparative Advantage
Extensions of the Ricardian Model
We may still consider the effect of relaxing three
of the assumptions identified in the simple model
Resources move freely from the production of one good
to another
Constant returns to scale
Trade does not change a countrys stock of resources or
the efficiency with which the resources are utilized
Heckscher-Ohlin Theory
Eli Heckscher and Bertil Ohlin put forward a
different explanation of comparative advantage
It arises from differences in national factor
endowments
By factor endowments, they meant the extent to
which a country is endowed with such resources
as land, labour, and capital
Impact on costs?
50
Heckscher-Ohlin Theory
The Heckscher-Ohlin theory attempts to
explain the pattern of international trade
that we observe in the world economy
The theory predicts that countries will
export those goods that make extensive use
of factors that are locally abundant, while
importing goods that make intensive use of
factors that are locally scarce
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Heckscher-Ohlin Theory
Like Ricardos theory, the Heckscher-Ohlin
theory argues that free trade is beneficial
Unlike Ricardos theory, however, the
Heckscher-Ohlin theory argues that the
pattern of international trade is determined
by differences in factor endowments, rather
than differences in productivity
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Heckscher-Ohlin Theory
Examples: US and China?
It is relative not absolute, endowments that
are important
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instruments,
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Questions
Mercantilism is a bankrupt theory that has
no place in the modern world. Discuss
Is free trade fair? Discuss
What are the potential costs of adopting a
free trade regime? Do you think
governments should do anything to reduce
these costs? Discuss
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