Introduction• It is the branch of economics which deals with the dynamics of: – International Trade – Exchange rate – Foreign Investment – Global financial system• It is a branch of International Economics• It is concerned with understanding all the procedures, techniques & tools related to helping firm in accessing global markets for short/long term funds
• International trade – Applies microeconomic models to understand the emergence and significance of international trade • Why? – Theories international trade – Their practical application • Different types of trade policy – free, restricted, etc. • How composition of international trade changes due to changes in economic conditions, etc.
What is International Trade??• International trade is a cross border trade• It refers to exchange of capital, goods, services, and across international borders or territories• Without international trade, nations would be limited to the goods and services produced within their own borde rs• Each country has scarce resources / specific skills – better to produce some, rather than all – to optimize the utilization
Absolute Advantage theory• Adam Smith – trade b/w two nations is based on absolute advantage• When one nation is more efficient (has absolute advantage) than another in production of A, but• Less efficient (has absolute disadvantage) in production of B• Both nations can gain by each specializing in production of good of its absolute advantage• Numerical example – next slide
3-1• Assume - Total resources for each X & Y = 200 Mhrs – X requires 10 Mhrs for 1 unit of rice & 20 Mhrs for 1 unit of wheat – Y requires 40 Mhrs for 1 unit of rice & 10 Mhrs for 1 unit of wheat Country Rice Wheat Before Trade Absolute Advantage X 10 5 X – Rice Y 2.5 10 Y - Wheat Total 12.5 15 Production with Consumption after Gain from specialization trade of 6 units specialization and each trade Country Rice Wheat Rice Wheat Rice Wheat X 20 0 14 6 4 1 Y 0 20 6 14 3.5 4 Total 20 20 20 20 7.5 5
Comparative Advantage theory• Ricardo – even if one nation is less efficient (has absolute disadvantage) in both A & B than other nation• Still it is beneficial for trade
Example - Comparative Advantage• Total resources for each X & Y = 200 Mhrs• Country X requires10 Mhrs for 1 unit of rice and 13.33 Mhrs for 1 unit of wheat• Country requires 40 Mhrs for 1 unit of rice and 20 Mhrs for 1 unit of wheat Country Rice Wheat X 10 7.5 Y 2.5 5 Total 12.5 12.5 • Absolute Advantage – X in both products • Comparative Advantage – Y in wheat
Example – Gains from trade Production Production Consumption Gain from without with after trade of specialization specialization specialization 4 units each and tradeCountry Rice Wheat Rice Wheat Rice Wheat Rice Wheat X 10 7.5 15 3.75 11 7.75 1 0.25 Y 2.5 5 0 10 4 6 1.5 1 Total 12.5 12.5 15 13.75 15 13.75 2.5 1.25
Heckscher-ohlin Theory / Factor Endowment Theory - Assumptions:• 2 countries, 2 goods and 2 Factor of production (FOP) i.e. L, K• Two factors are available in fixed amounts in each of the two countries; they are fully mobile b/w industries within each country; but immobile b/w countries• Two countries are alike in every respect except for their endowments of two factors• For each of the two goods, required technology is available
Heckscher-ohlin Theory / Factor Endowment Theory• A country is labor-abundant if it has a higher ration of labor to other factors than does the rest of the world• A product is labor-intensive if labor costs are a greater share of its value than the are of the value of other products.• A country has comparative advantage in the good that is relatively intensive in the country’s relatively abundant factor• Export – commodity intensive in its relatively abundant & cheap factor of production (FOP)• Import – commodity intensive in its relatively scarce & expensive factor of production (FOP)
Empirical Test of H-O Model (Leontief Paradox)• Wassily W. Leontief made an attempt to test the Heckscher-Ohlin theory empirically.• In 1954, Leontief found that the U.S. (the most capital-abundant country in the world) exported labor- intensive commodities and• imported capital-intensive commodities, in contradiction with Heckscher-Ohlin theory ("H-O theory").• This contradiction is called as Leontief Paradox• Leontiefs paradox undermined the validity of the Heckscher-Ohlin theorem (H-O) theory
Arguments to support HO Model• Some economists argue that the U.S. has an advantage in highly skilled labor more so than capital.• This can be seen as viewing "capital" more broadly, to include human capital.• Using this definition, the exports of the U.S. are very (human) capital-intensive, and not particularly intensive in (unskilled) labor.
Overlapping product Ranges Theory• The type, complexity and diversity of product demands of a country increase as countrys income increases.• International trade patterns would follow this principle• So that countries of similar income per capita levels will trade most intensively having overlapping product demands• According to Linder - nations with similar demands would develop similar industries.• These nations would then trade with each
Overlapping product Ranges Theory• For instance, both the U.S. and Germany are developed countries with a significant demand for cars, so both have large automotive industries (overlapping product demands)• Rather than one country dominating the industry with a comparative advantage - both countries trade different brands of cars between them.
Product Life Cycle Theory• The product life-cycle theory looks at the potential export possibilities of a product in five discrete stages in its life- cycle
• Stage 1: Introduction – A new product is manufactured in the innovating country and sold primarily in that domestic market – Any overseas sales are generated through exports to other markets – At this stage the innovating company has little competition in markets abroad.• Stage 2: Expansion – Sales increase, but so does competition as other firms enter the arena – At this point, the firm begins some production abroad, to serve foreign markets and to counter the competition
• Stage 3: Maturity – Exports from the home country decrease, because of increased production in overseas locations. – Price has become a critical determinant of competitiveness, so minimising costs becomes an important objective. – Production may shift to less developed countries to take advantage of lower labour costs – At this point, domestic production may cease and the product is imported by the home market.
• Stage 4: Sales decline – This occurs because competitors have achieved economies of scale equal to those of the innovator.• Stage 5: Demise – The innovator may cease production and leave the declining market to imitators – Products popularity has also ceased and consumers seek other products.• This theory holds - for products such as consumer durables, synthetic fabrics and electronic equipment;• Products which have a long time-span from innovation to eventual peak consumer demand.