Free Trade
refers to a situation where 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 country
Benefits of Trade
Smith, Ricardo and Heckscher-Ohlin show why it is beneficial for a country to engage in international trade even for products it is able to produce for itself
Benefits of Trade
International trade allows a country:
to specialize in the manufacture and export of products that it can produce efficiently
import products that can be produced more efficiently in other countries
Trade Theory and Government Policy
- Mercantilism makes a crude case for government involvement in promoting exports and limiting imports
- Smith, Ricardo, and Heckscher-Ohlin promote unrestricted free trade
- New trade theory and Porter's theory of national competitive advantage justify l
Mercantilism
- Mercantilism suggests that it is in a country's best interest to maintain a trade surplus -- to export more than it imports
- Mercantilism advocates government intervention to achieve a surplus in the balance of trade
- It views trade as a zero-sum game
Absolute Advantage
- Adam Smith argued that a country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it
- According to Smith, countries should specialize in the production of goods for which they have a
Comparative Advantage
- David Ricardo asked what might happen when one country has an absolute advantage in the production of all goods
- Ricardo's theory of comparative advantage suggests that countries should specialize in the production of those goods they produce most effi
Qualification and Assumptions
The simple example of comparative advantage assumes:
- only two countries and two goods
- zero transportation costs
- similar prices and values
- resources are mobile between goods within countries, but not across countries
- constant returns to scale
- f
Extensions of The Ricardian Model
- Resources do not always move freely from one economic activity to another, and job losses may occur
- Unrestricted free trade is beneficial, but because of diminishing returns, the gains may not be as great as the simple model would suggest
Opening a co
The Samuelson Critique
- Paul Samuelson argues that dynamic gains from trade may not always be beneficial
- The ability to offshore services jobs that were traditionally not internationally mobile may have the effect of a mass inward migration into the United States, where wage
Heckscher- Ohlin Theory
- Ricardo's theory suggests that comparative advantage arises from differences in productivity
- Eli Heckscher and Bertil Ohlin argued that comparative advantage arises from differences in national factor endowments - the extent to which a country is endo
All of the following theories advocated free trade except:
**Mercantilism
- Comparative Advantage
- Absolute Advantage
- Hecksher-Ohlin
The Leontief Paradox
- Wassily Leontief theorized that since the U.S. was relatively abundant in capital compared to other nations, the U.S. would be an exporter of capital intensive goods and an importer of labor-intensive goods.
- However, he found that U.S. exports were le
Which theory suggested that comparative advantage arises
from differences in national factor endowments?
- mercantilism
- absolute advantage
**Heckscher-ohlin
- comparative advantage
The Product Life Cycle Theory
- The product life-cycle theory, proposed by Raymond Vernon, suggested that as products mature both the location of sales and the optimal production location will change affecting the flow and direction of trade
- Vernon argued that the size and wealth of
Which theory suggests that as products mature the optimal
production location will change?
- Mercantilism
- Comparative
Advantage
- Absolute Advantage
**Product life-cycle
New Trade Theory
New trade theory suggests that the ability of firms to gain economies of scale (unit cost reductions associated with a large scale of output) can have important implications for international trade
New Trade Theory suggests that:
- through its impact on economies of scale, trade can increase the variety of goods available to consumers and decrease the average cost of those goods
- in those industries when output required to attain economies of scale represents a significant propor
Increasing Product Variety and Reducing Costs
- Without trade, nations might not be able to produce those products where economies of scale are important
- With trade, markets are large enough to support the production necessary to achieve economies of scale
- So, trade is mutually beneficial because
Economies of Scale, First Mover Advantage, and the Pattern of Trade
- The pattern of trade we observe in the world economy may be the result of first mover advantages (the economic an strategic advantages that accrue to early entrants into an industry) and economies of scale
- New trade theory suggests that for those prod
Economies of scale and first mover advantages are important to which trade theory?
- Mercantilism
- Product life cycle
**New trade theory
- Comparative advantage
National Competitive Advantage: Porter's Diamond
- Michael Porter tried to explain why a nation achieves international success in a particular industry and identified four attributes that promote or impede the creation of competitive advantage:
- Factor endowments
- Demand conditions
- Relating and supp
Factor Endowments
- Factor endowments refer to a nation's position in factors of production necessary to compete in a given industry
- A nation's position in factors of production can lead to competitive advantage
- These factors can be either basic (natural resources, cli
Demand Conditions
- Demand conditions refer to the nature of home demand for the industry's product or service
- The nature of home demand for the industry's product or service influences the development of capabilities
- Sophisticated and demanding customers pressure firm
Relating and Supporting Industries
- Relating and supporting industries refer to the presence or absence of supplier industries and related industries that are internationally competitive
- The presence supplier industries and related industries that are internationally competitive can spi
Firm Strategy, Structure, and Rivalry
- Firm strategy, structure, and rivalry refers to the conditions governing how companies are created, organized, and managed, and the nature of domestic rivalry
- The conditions in the nation governing how companies are created, organized, and managed, an
Evaluating Porter's Theory
Government policy can:
- affect demand through product standards
- influence rivalry through regulation and antitrust laws
- impact the availability of highly educated workers and advanced transportation infrastructure.
- The four attributes, government p
Porter's diamond of competitive advantage includes all of
the following except:
-Factor endowments
-Demand conditions
**First-mover advantages
- Firm strategy, structure, and rivalry
Implications for Managers
There are three main implications for international
businesses:
- location implications
- first-mover implications
- policy implications
Location
- Different countries have advantages in different productive activities
- It makes sense for a firm to disperse its various productive activities to those countries where they can be performed most efficiently
- International trade theory suggests that f
First-Mover Advantage
- Being a first mover can have important competitive implications, especially if there are economies of scale and the global industry will only support a few competitors
- Firms that establish a first-mover advantage may dominate global trade in that prod
Government Policy
- Government policies with respect to free trade or protecting domestic industries can significantly impact global competitiveness
- Businesses should work to encourage governmental policies that support free trade
- Firms should also lobby the government
_________ refer to the nature of home demand for the industry's product or service.
**Demand conditions
- Factor endowments
- Firm strategy, structure, and rivalry
- Related and supporting industries