ppt ch03

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea

Slides prepared by John Gionea

USEU

Australia

China

Chapter 3: International Trade Theory

Comparative

advantage New TradeTheory

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Absoluteadvantage

Absoluteadvantage

PORTER’S DIAMOND

FACTOR

ENDOWMENTS



TOPIC PLAN:

Mercantilism Absolute advantage Comparative advantage Comparative advantage versus competitive

advantage Factor endowments The New Trade Theory Porter’s Diamond

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Mercantilism: mid-16th century

A nation’s wealth depends on accumulation of precious metals (e.g. holdings of gold and silver).

Theory says you should have a trade surplus. » Maximize exports through subsidies.» Minimize imports through tariffs and quotas.

David Hume (1752): persistent trade surplus will affect the money supply and in the long run close the trade surplus

Key problem: “Zero-sum game”.

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Theories of International Trade:Absolute Advantage

The exporting country holds a superiority in the availability of certain goods. Reasons:» Climate,quality of land, and natural resources.» Differences in labour, capital, technology and

entrepreneurship Beef Computer Printers (tonnes) (units) Australia 800 200 Japan 400 500• Australia has an absolute advantage in beef, while

Japan has an absolute advantage in printers.

.

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Theory of Comparative Advantage

David Ricardo (1817) One country has a comparative

advantage over another in the production of a certain commodity if its opportunity cost of producing that commodity is lower

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Alternative production possibilities

from 100 units of resources

Commodity Country

Cheese (tonnes)

Cloth (bolts)

Australia 200 160

U.K. 80 120

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Opportunity Cost and Comparative Advantage

Production Australia U.K

1 tonne of cheese

0.8 bolts of cloth

1.5 bolts of cloth

1 bolt of cloth

1.25 tonne of cheese

0.67 tonnes of cheese

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Diversified production before trade

Production/Consumption

Resources (units)

Cloth (bolts)

Australia 100 37.5 x 1.6=60

U.K. 100 120

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The Theory of Comparative Advantage and the Gains from Trade

Cheese (tonnes) Cloth (bolts)

Production and Consumption without Trade

Australia 125 60 U.K. 40 60

Total production 165 120Production with Trade Specialization

Australia 200 - U.K - 120

Total production 200 120Consumption after U.K. Trades 60Bolts of Cloth for 60 tons of

Australian Cheese

Australia 140 60 U.K. 60 60 Increase in Consumption as a Result of Specialization and Trade

Australia 15 0U.K 20 0

3- 9Total consumption 35 0



Comparative versus Competitive Advantage

Comparative advantage is a concept based on relative costs of production (and opportunity cost) between nations.

Competitive advantage is a concept used to compare two company’s ability to compete in the same business.

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Factor Endowments(Heckscher and Ohlin)

Explains differences in opportunity costs Factor endowment: A country’s share of factors of

production (e.g. land,capital, labour,enterprise). Countries will specialise in those goods which

make more intensive use of the abundant/cheap factors.» Cheese:land-intensive» Cloth: labour-intensive

The theory can explain the Australia-Japan trade patterns

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Limitations of the Trade Theory

The theory disregards a number of considerations :» The difficulty in moving resources in the desired

industries» Fluctuations in demand» Trade barriers» Other political restraints

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The New Trade Theory

Began to be recognised in the 1970s. Deals with the returns on specialisation

where substantial economies of scale are present.» Specialisation increases output, ability to

enhance economies of scale increase.» In some industries there are likely to be

only a few profitable firms.

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The New Trade Theory

Thus firms with first mover advantages will develop economies of scale and create barriers to entry for other firms.

The commercial aircraft industry is an excellent example (eg. Boeing, Airbus)

New trade theory does NOT contradict the theory of comparative advantage, but instead identifies a source of comparative advantage

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Implications from the application of the New Trade Theory

Typically, requires industries with high, fixed costs.

World demand will support few competitors. Competitors may emerge because “they got there

first”» first-mover advantage.

Some argue that it generates government intervention and strategic trade policy (e.g. the need to nurture and protect “first movers”)

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National Competitive Advantage:

Porter’s Diamond(Harvard Business School, 1990)

Looked at 100 industries in 10 nations.» Thought existing theories didn’t go far enough.

Results contained in The Competitive Advantage of Nations.

Question: “Why does a nation achieve international success in a particular industry?” (e.g. Switzerland in Watches and Pharmaceuticals; Finland in Mobile Phones)

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Determinants of National Competitive Advantage

Firm StrategyStructure, andRivalry

Related and Supporting Industries

Demand Conditions

Factor Endowments

Government

Chance

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The Diamond

Success occurs where these attributes exist.» More/greater the attribute, the higher

chance of success. The four attributes, government policy and

chance work as a reinforcing system. Nokia is a good example of a firm which

has built its competitive advantage as a result of factors in Porter’s diamond.

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Evaluating Porter’s Theory

If Porter is right, his model is expected to predict the pattern of international trade in the real world:» a country’s exports should reflect the

presence of the four ‘diamond’ components. » Countries will import in those areas where

the components are not favorable. This theory is too new. Requires independent

empirical testing.

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ppt ch03

Business

hill australia pty

trade surplus

competitive advantage

comparative advantage

international trade

absolute advantage

porters diamond

opportunity cost