Theories of International

Trade
1-1
International Trade Theory
What is international trade?
Exchange of factors and goods
across national borders
1-2
International Trade Theory
Classical trade theories:
explain how country advantages enable
such exchange to happen
New trade theories:
explain links among natural country
advantages, government action, and
industry characteristics
Implications for International Business
1-3
Open Economies
Are open to competition from overseas
Have a high percentage of GDP
exported
Have few restrictions on trade with the
rest of the world
1-4
Exports and Imports, per cent of GDP
Exports Imports
Australia 20 21
Japan 12 17
United States 12 13
OECD total 26 16
UK 33 19
EU 15 37 19
Canada 44 18
Sweden 52 24





1-5
An Example: Australia
In terms or world trade:
Australia is not a very open economy.
As a proportion on GDP, Australias
exports and imports are around 40%
This is lower than many of our trading
partners.


1-6
An Open Economy?
In terms of free trade:
Australia is a very open economy
Australia has removed tariff protection
from almost all goods, except for motor
vehicles and clothing and footwear
Benefits of free trade include lower cost
inputs and consumer goods, and
efficiency gains.
1-7
Classical Trade Theories
Mercantilism
Free Trade theories
Absolute Advantage
Comparative Advantage
Specialization of production and free
flow of goods benefit all trading
partners economies
International product life cycle
1-8
Mercantilism
Maintain a trade surplus
Zero sum game
Theory is flawed
Still influential

1-9
Absolute Advantage
A country
should specialize in production of
and export products for which it has
absolute advantage; import other
products
has absolute advantage when it is
more productive than any other
country in producing a particular
product

1-10
The theory of absolute advantage
1-11
Copyright 2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Global Business Today 1e by Hill. Slides prepared by Fuming Jiang.

Comparative Advantage
Country should specialize in the
production of those goods in which it is
relatively more productive... even if it
has absolute advantage in all goods it
produces
Absolute Advantage is a special case of
Comparative Advantage
1-12
Ricardos theory of comparative advantage
1-13
Copyright 2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Global Business Today 1e by Hill. Slides prepared by Fuming Jiang.

Comparative Advantage
Extension of rationale for domestic
market
Relative efficiency
Relative abundance of factors of
production
1-14
Leontief paradox
US has relatively more abundant capital
yet imports goods more capital intensive
than those it exports
Explanation
US has special advantage on producing
new products made with innovative
technologies
These may be less capital intensive till
they reach mass-production state

1-15
What does Australia have in
abundance?
Minerals
Energy
Land
Skilled labour
Other
1-16
Product Life-Cycle
Most new products conceived / produced in
the US in 20th century
US firms kept production close to their
market initially
Minimize risk of new product
introductions
Demand not based on price; low
product cost not an issue

1-17
Product Life Cycle- US
Time
Quantity
Consumption
Production
Exports
Imports
1-18
Product Life-Cycle
Limited initial demand in other advanced
countries
Exports more attractive than overseas
production
When demand increases in advanced
countries, production follows

1-19
Product Life Cycle- Other Advanced
Countries
Time
Quantity
Consumption
Production
Exports
Imports
1-20
Product Life-Cycle
With demand expansion in secondary
markets
product becomes standardized
production moves to low production
cost areas
product now imported to US and to
advanced countries

1-21
Product Life Cycle- Developing
Country
Time
Quantity
Consumption
Production
Exports
Imports
1-22
Classic Theory Limitations
Simple world (two countries, two products)
no transportation costs
no price differences in resources
resources immobile across countries
constant returns to scale
each country has a fixed stock of resources
and no efficiency gains in resource use
from trade
full employment
1-23
The New Trade Theory
Output expands with specialization,
economies of scale realized & unit costs
decrease
Because of scale economies, world demand
supports only a few firms in such industries
Countries that had an early entrant to such an
industry have an advantage:
Fist-mover advantage
Barrier to entry
1-24
New Trade Theory
Global Strategic Rivalry
Firms gain competitive advantage
through: intellectual property, R&D,
economies of scale and scope,
experience
1-25
1-26
Economies of Scale
New Trade Theories
Increasing returns of specialization
due to economies of scale
First mover advantages (economies of
scale such that barrier to entry created
for second or third company)
Luck... first mover may be simply
lucky
Government intervention: strategic
trade policy
1-27
National Competitive Advantage
Factor endowments
land, labor, capital, workforce,
infrastructure
(some factors can be created...)
Demand conditions
large, sophisticated domestic
consumer base: offers an
innovation friendly environment
and a testing ground
1-28
National Competitive Advantage
Related and supporting industries
local suppliers cluster around
producers and add to innovation
Firm strategy, structure, rivalry
competition good, national
governments can create
conditions which facilitate and
nurture such conditions
1-29
1-30
Porters Diamond
Implications for IB
First mover implications
Location Implications
Foreign Investment Decisions
Government Policy implications
1-31