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Adam Smith theory of international trade
Adam Smith theory of international trade
Adam Smith theory of international trade
Adam Smith theory of international trade
Adam Smith theory of international trade
Adam Smith theory of international trade
Adam Smith theory of international trade
Adam Smith theory of international trade
Adam Smith theory of international trade
Adam Smith theory of international trade
Adam Smith theory of international trade
Adam Smith theory of international trade
Adam Smith theory of international trade
Adam Smith theory of international trade
Adam Smith theory of international trade
Adam Smith theory of international trade
Adam Smith theory of international trade
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Adam Smith theory of international trade

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  • 1. International Trade Theory Chapter 4
  • 2. International Trade Theory
    • Overview
    • Mercantilism
    • Absolute Advantage
    • Comparative Advantage
    • Heckscher-Olin Theory
    • Product Life Cycle Theory
    • New Trade Theory
    • Porter’s Diamond
    © McGraw Hill Companies, Inc.,2000 4-1
  • 3. An Overview of Trade Theory
    • Free Trade occurs when 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.
    • The Benefits of Trade allow a country to specialize in the manufacture and export of products that can be produced most efficiently in that country.
    • The Pattern of International Trade displays patterns that are are easy to understand (Saudi Arabia/oil or Mexico/labor intensive goods). Others are not so easy to understand (Japan and cars).
    © McGraw Hill Companies, Inc.,2000 4-5
  • 4. Mercantilism: mid-16 th century
    • A nation’s wealth depends on accumulated treasure
    • Gold and silver are the currency of trade.
    • Theory says you should have a trade surplus.
      • Maximize exports through subsidies.
      • Minimize imports through tariffs and quotas.
    • Flaw: “Zero-sum game”.
    © McGraw Hill Companies, Inc.,2000 4-6
  • 5. David Hume - 1752
    • Increased exports leads to inflation and higher prices.
    • Increased imports lead to lower prices.
    • Result: Country A sells less because of high prices and Country B sells more because of lower prices.
    • In the long run, no one can keep a trade surplus.
    © McGraw Hill Companies, Inc.,2000 4-7
  • 6. Theory of Absolute Advantage
    • Adam Smith: Wealth of Nations ( 1776).
    • Capability of one country to produce more of a product with the same amount of input than another country.
    • Produce only goods where you are most efficient, trade for those where you are not efficient.
      • Trade between countries is, therefore, beneficial.
    • Assumes there is an absolute advantage balance among nations.
    • Ghana/cocoa.
    © McGraw Hill Companies, Inc.,2000 4-8
  • 7. Theory of Comparative Advantage
    • David Ricardo: Principles of Political Economy ( 1817).
      • Extends free trade argument
      • Efficiency of resource utilization leads to more productivity.
      • Should import even if country is more efficient in the product’s production than country from which it is buying.
        • Look to see how much more efficient. If only comparatively efficient, than import.
    • Makes better use of resources
    • Trade is a positive-sum game.
    © McGraw Hill Companies, Inc.,2000 4-11
  • 8. Simple Extensions of the Ricardian Model
    • Diminishing returns:
      • More a country produces, at some point, will require more resources.
    • However:
      • Free trade can increase a country’s production resources, and
      • Increase the efficiency of resource utilization.
    © McGraw Hill Companies, Inc.,2000 4-14
  • 9. Is the Mercantilist Theory Still Valid?
    • A qualified Yes.
    • Equate political power with economic power and economic power with a trade surplus.
    • Japan
    © McGraw Hill Companies, Inc.,2000 4-17
  • 10. Heckscher (1919)-Olin (1933) Theory
    • Export goods that intensively use factor endowments which are locally abundant.
      • Corollary: import goods made from locally scarce factors.
    • Patterns of trade are determined by differences in factor endowments - not productivity.
    • Remember, focus on relative advantage, not absolute advantage.
    © McGraw Hill Companies, Inc.,2000 4-18
  • 11. The Leontief Paradox, 1953
    • Disputes Heckscher-Olin in some instances.
    • Factor endowments can be impacted by government policy - minimum wage.
    • US tends to export labor-intensive products, but is regarded as a capital intensive country.
    © McGraw Hill Companies, Inc.,2000 4-19
  • 12. Heckscher vs Ricardo
    • Economists prefer Heckscher on theoretical grounds but is a relatively poor predictor of trade patterns.
    • Ricardo’s Comparative Advantage Theory, regarded as too limited for predicting trade patterns, actually predicts them with greater accuracy.
    • In the end, differences in productivity may be the key to determining trade patterns.
    © McGraw Hill Companies, Inc.,2000 4-20
  • 13. Product Life-Cycle Theory ( Raymond Vernon, 1966 )
    • Article in the Quarterly Journal of Economics.
    • As products mature, both location of sales and optimal production changes.
    • Affects the direction and flow of imports and exports.
    • Globalization and integration of the economy makes this theory less valid.
    © McGraw Hill Companies, Inc.,2000 4-21
  • 14. The New Trade Theory
    • Began to be recognized in the 1970s.
    • Deals with the returns on specialization where substantial economies of scale are present.
      • Specialization increases output, ability to enhance economies of scale increase.
    © McGraw Hill Companies, Inc.,2000 4-23
  • 15. First-Mover Advantage
    • Economies of scale may preclude new entrants.
    • Role of the government.
    © McGraw Hill Companies, Inc.,2000 4-25
  • 16. Porter’s Diamond ( Harvard Business School, 1990)
    • The Competitive Advantage of Nations.
    • Looked at 100 industries in 10 nations.
      • Thought existing theories didn’t go far enough.
    • Question: “Why does a nation achieve international success in a particular industry?”
    © McGraw Hill Companies, Inc.,2000 4-29
  • 17. Implications for Business
    • Location implications: makes sense to disperse production activities to countries where they can be performed most efficiently.
    • First-mover implications: It pays to invest substantial financial resources in building a first-mover, or early-mover, advantage.
    • Policy implications: promoting free trade is generally in the best interests of the home-country, although not always in the best interests of the firm. Even though, many firms promote open markets.
    4-42

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