grp3 international trade theories m2
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INTERNATIONAL
TRADE THEORY
Presented By,Ravish Kumar-64
Ranjan Kumar-171Ankit Semwal-125
OBJECTIVES
Define the term international trade and discuss the role of mercantilism in modern
international trade.Contrast the theories of absolute advantage
and comparative advantage.Relate the importance of international product life cycle theory to the study of
international economics.
INTRODUCTION
International trade: the branch of economics concerned with the exchange of goods and services with foreign countries.
We will focus on:International trade theory
WHY DO NATIONS TRADE?
Trade theories:Mercantilism;
theory of absolute advantage;theory of comparative advantage;
factor endowment theory;international product cycle theory;
other considerations.
Trade theory-overview
Free Trade occurs when a government does not attempt to influence, through quotas or duties, what its citizens can buy from another country or what they can produce and sell to another countryThe Benefits of Trade allow a country to specialize in the manufacture and export of products that can be produced most efficiently in that country
MERCANTILISM MID- 16TH CENTURY
A trade theory which holds that a government can improve the well-being of the country
by encouraging exports and stifling imports.
Cf.) Neo mercantilism: without the reliance on precious metal (gold).
A nation’s wealth depends on accumulated “treasure”Gold and silver are the currency of trade
Mercantilists sought what we now call ‘development’
They argued their countries should run a trade surplus Maximize export through subsidiesMinimize imports through tariffs and quotas
Flaw: “zero-sum game”Mercantilists neglected to see the benefits of trade
CONTD..
But there was a flaw in But there was a flaw in the mercantilists’ argumentthe mercantilists’ argument
They assumed that trade was a zero-sum game As England, France, and the Netherlands competed with each other, many thought only about advantage for their country
THEORY OF ABSOLUTE ADVANTAGE
A trade theory which holds that by specializing in the production of goods, which they can produce more efficiently than any others, nations can increase their economic well-
being.An exampleAssume:
labour is the only cost of production;lower labour-hours per unit of production means
lower production costs and higher productivity of labour.
North has an absolute advantage in the production of cloth.South has an absolute advantage in the production of grain.
It follows that:If North produces cloth and South produces grain, and an
exchange ratio can be arranged, both the countries will benefit from trade.
Theory of absolute advantage (Continued)
THEORY OF COMPARATIVE ADVANTAGE
A trade theory which holds that nations should produce those goods for which they
have the greatest relative advantage. An exampleAssume:
labour is the only cost of production;
lower labour-hours per unit of production means lower production costs and higher
productivity of labour.
North has an absolute advantage in the production of both cloth and grain but the relative costs differ (i.e. gains from trade).
In North, one unit of cloth costs 50/100 hours of grain.In South, one unit of cloth costs 100/100 hours of grain.
It follows that:If North can import more than a half unit of grain for one unit of cloth,
it will gain from trade.If South can import one unit of cloth for less than one unit of grain, it
will also gain from trade.Under the circumstance presented in the above example, both countries
can benefit from trade.
Theory of comparative advantage (Continued)
FACTOR ENDOWMENT THEORY
Also known as the Heckscher-Ohlin theory, It extends the concept of comparative advantage by
bringing into consideration the endowment and cost of factors of production and helps to explain
why nations with relatively large labour forces will concentrate on producing labour-intensive goods,
whereas, countries with relatively more capital than labour will specialize in capital-intensive
goods.
Weaknesses of factor endowment theory:Some countries have minimum wage laws that result
in high prices for relatively abundant labour.The Leontief paradox: countries like the United
States actually export relatively more labour-intensive goods and import capital-intensive
goods.
No single theory can explain the role of economic factors in trade theory.
INTERNATIONAL PRODUCT LIFE CYCLE THEORY (IPLC)
A theory of the stages of production for a product with new “know-how”: it is first produced by the parent firm, then by its
foreign subsidiaries and finally anywhere in the world where costs are the lowest; it
helps to explain why a product that begins as a nation’s export often ends up as an import.
The international product life cycleSource: Raymond Vernon and Louis T. Wells, Jr., The Manager in the International Economy (Englewood Cliffs, NJ: Prentice Hall, 1991), p. 85
THE RICARDIAN MODELImmobile resources:
Resources do not always move easily from one economic activity to another
Diminishing returns:Diminishing returns to specialization suggests that after some point, the more units of a good the country produces, the greater the additional resources required to produce an additional itemDifferent goods use resources in different proportions
Free trade (open economies):Free trade might increase a country’s stock of resources (as labor and capital arrives from abroad)Increase the efficiency of resource utilization
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NEW TRADE THEORY-APPLICATIONS
Typically, requires industries with high, fixed costs
World demand will support few competitors
Competitors may emerge because of “ First-mover advantage”
Economies of scale may preclude new entrants
Role of the government becomes significantSome argue that it generates government intervention and
strategic trade policy
Commonly used barriers to trade
Price-based barriers Tariffs: a tax on goods shipped internationally
Quantity limits Quotas: a quantity limit on imported goods Embargos: a quota set to zero
International price fixing A cartel: a group of firms that collectively agree to fix prices or
quantities sold in an effort to control price
Non-tariff barriers Financial limits Exchange controls: controls that restrict the flow of currency
Foreign investment controls Limits on FDI Limits on transfer or remittance of funds
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THEORY OF NATIONAL COMPETITIVE ADVANTAGE
The theory attempts to analyze the reasons for a nations success in a particular industry
Porter studied 100 industries in 10 nations
postulated determinants of competitive advantage of a nation were based on four major
attributes
Factor endowments
Demand conditions
Related and supporting industries
Firm strategy, structure and rivalry
OTHER CONSIDERATIONS
Government regulation
Monetary currency valuation
Consumer tastes
A Link Between Trade and Growth
Sachs and Warner: 1970 to 1990 study
Open economy developing countries grew 4.49%/year.Closed economy developing countries grew 0.69%/year.Open economy developed countries grew 2.29%/year.Closed economy developed countries grew 0.74%/year.
Frankel and Romer:
On average, a one percentage point increase in the ratio of a country’s trade to its GDP increases income/person by at least 0.5%. For every 10% increase in the importance of international trade in an economy, average income levels will rise by at least 5%.
Barriers to trade
Reasons for barriers to trade
Protect local jobs by shielding home-country business from foreign competition.
Encourage local production to replace imports. Protect infant industries that are just getting started. Reduce reliance on foreign suppliers. Encourage local and foreign direct investment. Reduce balance of payments problems. Promote export activity. Prevent foreign firms from dumping, that is, selling goods
below cost in order to achieve market share. Promote political objectives such as refusing to trade with
countries that practice apartheid or deny civil liberties to their citizens.
Heckscher (1919)-Ohlin (1933) Theory
A country will export goods that use its abundant factors intensively, and import goods that use its scarce factors intensively.
It states "A capital-abundant country will export the capital-intensive good, while the labor-abundant country will export the labor-intensive good”.
The two countries are identical, except for the difference in resource endowments.
The relative abundance in capital will cause the capital-abundant country to produce the capital-intensive good cheaper than the labor-abundant country and vice versa.
The Leontief Paradox
Disputes Heckscher-Olin in some instances. The country with the world's highest capital-per
worker has a lower capital/labor ratio in exports than in imports.
Factor endowments can be impacted by government policy - minimum wage.
US tends to export labor-intensive products, but is regarded as a capital intensive country.
Diamond Model
Michael Porter The approach looks at clusters, a number of small
industries, where the competitiveness of one company is related to the performance of other companies and other factors tied together in the value-added chain, in customer-client relation, or in a local or regional contexts.
The Porter analysis was made in two steps. 1) Clusters of successful industries have been mapped in 10 important trading nations. 2) The history of competition in particular industries is examined to clarify the dynamic process by which competitive advantage was created.