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Grp3 international trade theories m2


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Grp3 international trade theories m2

  1. 1. INTERNATIONAL TRADE THEORY Presented By, Ravish Kumar-64 Ranjan Kumar-171 Ankit Semwal-125
  2. 2. OBJECTIVES Define the term international trade and discuss the role of mercantilism in modern international trade. Contrast the theories of absolute advantage and comparative advantage. Relate the importance of international product life cycle theory to the study of international economics.
  3. 3. INTRODUCTION International trade: the branch of economics concerned with the exchange of goods and services with foreign countries. We will focus on: International trade theory
  4. 4. WHY DO NATIONS TRADE? Trade theories: Mercantilism; theory of absolute advantage; theory of comparative advantage; factor endowment theory; international product cycle theory; other considerations.
  5. 5. Trade theory-overview 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
  6. 6. MERCANTILISM MID- 16TH CENTURY A trade theory which holds that a government can improve the well-being of the country by encouraging exports and stifling imports. Cf.) Neo mercantilism: without the reliance on precious metal (gold).
  7. 7. CONTD.. A nation’s wealth depends on accumulated “treasure” Gold and silver are the currency of trade Mercantilists sought what we now call ‘development’ They argued their countries should run a trade surplus Maximize export through subsidies Minimize imports through tariffs and quotas Flaw: “zero-sum game” Mercantilists neglected to see the benefits of trade
  8. 8. But there was a flaw in the mercantilists’ argument They assumed that trade was a zero-sum game As England, France, and the Netherlands competed with each other, many thought only about advantage for their country
  9. 9. THEORY OF ABSOLUTE ADVANTAGE A trade theory which holds that by specializing in the production of goods, which they can produce more efficiently than any others, nations can increase their economic well-being. An example Assume: labour is the only cost of production; lower labour-hours per unit of production means lower production costs and higher productivity of labour.
  10. 10. Theory of absolute advantage (Continued) North has an absolute advantage in the production of cloth. South has an absolute advantage in the production of grain. It follows that: If North produces cloth and South produces grain, and an exchange ratio can be arranged, both the countries will benefit from trade.
  11. 11. THEORY OF COMPARATIVE ADVANTAGE A trade theory which holds that nations should produce those goods for which they have the greatest relative advantage. An example Assume: labour is the only cost of production; lower labour-hours per unit of production means lower production costs and higher productivity of labour.
  12. 12. Theory of comparative advantage (Continued) North has an absolute advantage in the production of both cloth and grain but the relative costs differ (i.e. gains from trade). In North, one unit of cloth costs 50/100 hours of grain. In South, one unit of cloth costs 100/100 hours of grain. It follows that: If North can import more than a half unit of grain for one unit of cloth, it will gain from trade. If South can import one unit of cloth for less than one unit of grain, it will also gain from trade. Under the circumstance presented in the above example, both countries can benefit from trade.
  13. 13. FACTOR ENDOWMENT THEORY Also known as the Heckscher-Ohlin theory, It extends the concept of comparative advantage by bringing into consideration the endowment and cost of factors of production and helps to explain why nations with relatively large labour forces will concentrate on producing labourintensive goods, whereas, countries with relatively more capital than labour will specialize in capital-intensive goods. Weaknesses of factor endowment theory: Some countries have minimum wage laws that result in high prices for relatively abundant labour. The Leontief paradox: countries like the United States actually export relatively more labour-intensive goods and import capital-intensive goods. No single theory can explain the role of economic factors in trade theory.
  14. 14. INTERNATIONAL PRODUCT LIFE CYCLE THEORY (IPLC) A theory of the stages of production for a product with new “know-how”: it is first produced by the parent firm, then by its foreign subsidiaries and finally anywhere in the world where costs are the lowest; it helps to explain why a product that begins as a nation’s export often ends up as an import.
  15. 15. The international product life cycle Source: Raymond Vernon and Louis T. Wells, Jr., The Manager in the International Economy (Englewood Cliffs, NJ: Prentice Hall, 1991), p. 85
  16. 16. THE RICARDIAN MODEL Immobile resources: Resources do not always move easily from one economic activity to another Diminishing returns: Diminishing returns to specialization suggests that after some point, the more units of a good the country produces, the greater the additional resources required to produce an additional item Different goods use resources in different proportions Free trade (open economies): Free trade might increase a country’s stock of resources (as labor and capital arrives from abroad) Increase the efficiency of resource utilization
  17. 17. 4-17 NEW TRADE THEORYAPPLICATIONS Typically, requires industries with high, fixed costs World demand will support few competitors Competitors may emerge because of “ First-mover advantage” Economies of scale may preclude new entrants Role of the government becomes significant Some argue that it generates government intervention and strategic trade policy
  18. 18. Commonly used barriers to trade  Price-based barriers  Tariffs: a tax on goods shipped internationally  Quantity limits  Quotas: a quantity limit on imported goods  Embargos: a quota set to zero  International price fixing  A cartel: a group of firms that collectively agree to fix prices or quantities sold in an effort to control price  Non-tariff barriers  Financial limits  Exchange controls: controls that restrict the flow of currency  Foreign investment controls  Limits on FDI  Limits on transfer or remittance of funds
  19. 19. 4-19 THEORY OF NATIONAL COMPETITIVE ADVANTAGE The theory attempts to analyze the reasons for a nations success in a particular industry Porter studied 100 industries in 10 nations postulated determinants of competitive advantage of a nation were based on four major attributes Factor endowments Demand conditions Related and supporting industries Firm strategy, structure and rivalry
  20. 20. OTHER CONSIDERATIONS Government regulation Monetary currency valuation Consumer tastes
  21. 21. A Link Between Trade Open economy developing countries and Growth grew 4.49%/year. Closed economy developing countries grew Sachs and Warner: 1970 to 0.69%/year. 1990 study Open economy developed countries grew 2.29%/year. Closed economy developed countries grew 0.74%/year. Frankel and Romer: On average, a one percentage point increase in the ratio of a country’s trade to its GDP increases income/person by at least 0.5%. For every 10% increase in the importance of international trade in an economy, average income levels will rise by at least 5%.
  22. 22. Barriers to trade
  23. 23. Reasons for barriers to trade  Protect local jobs by shielding home-country business from foreign competition.  Encourage local production to replace imports.  Protect infant industries that are just getting started.  Reduce reliance on foreign suppliers.  Encourage local and foreign direct investment.  Reduce balance of payments problems.  Promote export activity.  Prevent foreign firms from dumping, that is, selling goods below cost in order to achieve market share.  Promote political objectives such as refusing to trade with countries that practice apartheid or deny civil liberties to their citizens.
  24. 24. Heckscher (1919)-Ohlin (1933) Theory  A country will export goods that use its abundant factors intensively, and import goods that use its scarce factors intensively.  It states "A capital-abundant country will export the capital-intensive good, while the laborabundant country will export the labor-intensive good”.  The two countries are identical, except for the difference in resource endowments.  The relative abundance in capital will cause the capital-abundant country to produce the capitalintensive good cheaper than the labor-abundant country and vice versa.
  25. 25. The Leontief Paradox  Disputes Heckscher-Olin in some instances.  The country with the world's highest capital-per worker has a lower capital/labor ratio in exports than in imports.  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.
  26. 26. Diamond Model  Michael Porter  The approach looks at clusters, a number of small industries, where the competitiveness of one company is related to the performance of other companies and other factors tied together in the value-added chain, in customerclient relation, or in a local or regional contexts.  The Porter analysis was made in two steps. 1) Clusters of successful industries have been mapped in 10 important trading nations. 2) The history of competition in particular industries is examined to clarify the dynamic process by which competitive advantage was created.