Chap. 2. economic rational of multinational trade & business
MKTG 26 - International Marketing
Chapter 2 – Economic Rational of Multinational
Trade and Business
PASIG CATHOLIC COLLEGE
Theory of Comparative Advantage
Modern trade take place because a foreign country is
able to provide a material or product cheaper than native
The theory of comparative advantage states that even if a
country is able to produce all its goods a lower costs than
another country can, trade still benefits both countries,
based on comparative, not absolute, cost.
Example:Theory of Comparative
COUNTRYCOUNTRY Hand CalculatorHand Calculator Bottles of WineBottles of Wine
United StateUnited State 66 88
ItalyItaly 3030 55
Labor Costs Per Unit ( In Hours )
Rational for Seeking Comparative
Every nation seeks to increase the material standard of
living of its people; living standard increase as a function
With greater productivity, the same amount of labor
yield more goods and services.
As productivity increases, greater material wealth results.
Ex. Sweden has made a choice of longer vacations; the
U.S. prefer increased material possession. Whatever the
eventual choice, increased productivity affords a wider
range of choice.
Relative Productivity :
A Hypothetical Example
OperatingOperating 11 33
Capital costCapital cost
TotalTotal 22 55
World Price -InWorld Price -In
Labor hr Equv.Labor hr Equv.
( per labor hr)( per labor hr)
Labor Hours per Barrel
Country A Country B
Business Specialization and Trade
The economic law of comparative advantage
states that every nation benefits when
specialization and trade take place. Even when
one nation cannot produce goods more efficiently
than another can, it is still in the economic
interest of both nation for each to specialize.
Business Specialization and Trade
Regardless of its productivity relative to other
suppliers, every nation has comparative advantages in
producing certain goods rather than others.
The specialization and the advantage are achieved on
the basis on one or more factors.
1. Natural resources 4. Managerial
2. Technology 5. Labor
Product Life Cycle and International
The product life cycle model states that products go through
the following four stages.
Phase I U.S. export strength builds
Phase II Foreign production starts
Phase III Foreign production becomes
competitive in export markets.
Phase IV Import competition begins in
domestic U.S. markets
The international theory assumes that the firm has a
global horizon, and it recognize that the enterprise
needs a competitive advantage or a unique asset to
Underlying thesis of internalization is the firm’s
desire to extend its own direct operation rather than
use external markets.
The internalization approach rests on two
(a) firms choose the least-cost location for each
activity they perform.
(b) firms grow by internalizing markets up to the
point where the benefits of further internalization
are outweighed by the costs.
The internalization theory provides an economic rationale for the
existence of MNC’s. The sourcing decision rests on the cost and
benefits to the firm, taking into consideration industry-specific
factors(e.g. nature of the product), region-specific factors(e.g.
geographic location), nation-specific factors (e.g. political climate),
and firm-specific factors(e.g. managerial ability to internalize).
The internationalization theory primarily focuses on the motives and
decision processes within the multinational firm but pay little
attention to the host country policies and other external factors that
may affect internalization cost/benefits.
Trade Barriers and Trade Liberation
Government impose all sorts of barriers to restrict
trade and business across national boundaries. But
there are reasons for trade barriers and for the effort
that have been made internationally to liberate
These are the two types of trade barriers:
To all nations except those that have tariff treaties with particular
country. A tariff may be worked out on the basis of a tax permit,
called specific duty, or as a percentage of Tariff refer to taxes levied
on goods moved between nations. The most important of these is the
tax usually called the custom duty that is levied by the importing nation.
But tax may also be imposed by the exporting nation, and that is called
an export tax.
Different nations handle tariff barriers differently.
1. A country may have a single tariff system for all goods from all sources.
This is called a unlinear or single-column tariff.
2. The general-conventional tariff implies f the value of the item, which is
referred to as advalorem tax.
Nontariff barriers include quotas, import
equalization taxes, road taxes, laws giving
preferential treatment to domestic suppliers,
administration of antidumping measures,
exchange controls, and a variety of ‘invisibe”
tariffs that impede trade.
The Principal Nontariff barriers in the
Specific limitation on trade
Customs and administrative entry procedures.
Government participation in trade
Charges on imports
others categories like voluntary export restraints and
ordinary marketing agreements.
Tariff Reduction Programs
Internationally, systematic tariff reduction program started
after world war II. In 1947, the U.S. and 22 other major
trading countries got together in Geneva to find ways to
reduce tariffs and remove trade barriers.
The General Agreement on Tariffs and Trade (GATT)
resulted. Since then, eight major efforts to reduce trade
barriers have been undertaken under GATT’s auspices.
Dimension of Agreement Under GATT
Major Agreement Number of
Value of world
1947 Geneva 23 $ 10.0 n.a.
33 n.a. n.a.
37 n.a. n.a.
1956 Geneva 35 2.5 4
40 4.9 7
( Kennedy Round)
70 40.0 35
Multilateral Trade Organization
The agreement creates a World Trading
Organization (WTO) to replace the GATT
secretariat, but details of the new organization’s
powers remain unclear.
The WTO would, however,, have more authority
to oversee trade in services and agriculture than
GATT now does.
U.S. Trade Liberalization
Liberalization of U.S. foreign trade began with enactment of
the Reciprocal Trade Agreement Act of 1934. With the act,
Congress authorized the president to reduce then-existing
tariff duties by 50 percent.
A noteworthy aspect of the act was the inclusion of the
most-favored-nation clause, which limited discrimination in
trade by extending to third parties the same terms provided
to contracting parties.
MNC’s and World Markets
Multinational corporations (MNC’s) are among the
most, if not the most, influential factors in global
economic life today. Within the last 30 years they have
become the most formidable single factor in world trade
MNC’s play a decisive role in the allocation and use of
the world resources. They conceive new products and
services, create and stimulate demand for them, and
develop new modes of manufacture and distribution.
We have examined the rationale for world trade and business
activity. The classic explanation of world trade is provided by the
theory of comparative advantage.
When one country has an advantage over another, not only in the
production of one product but all products, and its advantage in
the production of the one product is greater than its advantage in
the production of their other products, country, according to the
theory, has a comparative advantage, each country should figure
out which product have a comparative advantage and concentrate
its productive efforts on those other products should be imported