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
Australia 800 200
Japan 400 500
• Australia has an absolute advantage in beef, while Japan has an absolute advantage in printers.
3 - 4
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
Alternative production possibilities from 100 units of resources 3.6
Opportunity Cost and Comparative Advantage 3.7
Diversified production before trade Production/Consumption 3.8
The Theory of Comp arative 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 12 0 Production with Trade Specialization Australia 200 - U.K - 120 Total production 200 120 Consumption after U.K. Trades 60Bolts of C loth 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 0 U.K 20 0 3 - 9 Total 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.
3 - 10
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.
The theory can explain the Australia-Japan trade patterns
3 - 11
Limitations of the Trade Theory
The theory disregards a number of considerations :
The difficulty in moving resources in the desired industries
Fluctuations in demand
Other political restraints
3 -1 2
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.
3 -1 3
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
3 -1 4
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”
Some argue that it generates government intervention and strategic trade policy (e.g. the need to nurture and protect “first movers”)
3 -1 5
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)