That is the part of my book on international business. this is very informative. i complete this book in 1 year. that is very useful for master students.

1. ‘’Tell me and I forget, Teach me and I
may remember, involve me and I
learn’’
UMAIR FAROOQ MUGHAL

2.  After studying this Slide, you should be able to:
What is International Trade Theory
International Trade Theory Definitions
International Trade Theories [Why do Nations Trade]
Mercantilism
Theory of Absolute Advantage
Theory of Comparative Advantage
Heckscher-Ohlin Theory
The Product Life Cycle Theory
UMAIR FAROOQ MUGHAL

3.  Introduction:
International trade is the exchange of goods and
services between countries. International trade allows a
country to specialize in the manufacture and export of
products and services that it can produce efficiently
and import products and services that can be
produced more efficiently in other countries.
International trade theories are simply different theories
to explain international trade. Countries trade with each
other when they do not have the resources, or capacity
to satisfy their own needs and wants.
This presentation explains number of trade theories
which means why trade is beneficial for a country.
UMAIR FAROOQ MUGHAL

4.  Definitions:
 ‘’The exchange of capital, goods, and services
across international borders is called international
trade.’’
 ‘’The exchange of goods and services along
international borders is called international
trade.’’
UMAIR FAROOQ MUGHAL

5. International Trade Theories
(Why do Nations Trade?)
 Mercantilism
 Theory of Absolute Advantage
 Theory of Comparative Advantage
 Heckscher-Ohlin Theory
 The Product Life Cycle Theory
UMAIR FAROOQ MUGHAL

6. Mercantilism (mid-16th century)
 Definition
 ‘’Mercantilism trade theory holding that nations should
accumulate financial wealth, usually in the form of gold (forget
things like living standards or human development) by
encouraging exports and discouraging imports.’’
 ‘’Government of a country increase their export as compare to
import to maintain trade surplus is called Mercantilism trade
theory.’’
 Theory says you should have a trade surplus.
› Maximize export through subsidies.
› Minimize imports through tariffs and quotas.
› Mercantilism views trade as a zero-sum game - one in which a
gain by one country results in a loss by another
UMAIR FAROOQ MUGHAL

7. Theory of Absolute Advantage
 Definition:
‘’Theory of Absolute Advantage contain that
countries produce only those goods in which it is
more efficient & trade those goods in which it is
less efficient.’’
 In 1776, Adam Smith attacked the mercantilist assumption that trade is a zero-sum
game and argued that countries differ in their ability to produce goods efficiently, and
that a country has an absolute advantage in the production of a product when it is
more efficient than any other country in producing it.
 According to Smith, countries should specialize in the production of goods for which
they have an absolute advantage and then trade these goods for the goods produced
by other countries.
 In the theory of international trade, a country or firm has an absolute advantage if it
can produce a product (good or service) more efficiently (cheaply) than others.
UMAIR FAROOQ MUGHAL

8.  An example:
Assume:
 Assume that two countries, Japan & China, both have 200 labour
hours units of resources that could either be used to produce LED &
TAB
 Lower labour-hours per unit of production mean lower production
costs and higher productivity of labour.
 Only these two countries in the world.
 Only two products TAB & LED
 Trade 6 by 6
UMAIR FAROOQ MUGHAL

9. Labour Hours Required to Produce 1 Unit of LED & TAB
LED TAB
Japan 10 20
China 20 10
 Explanation:
 Japan need 10 labour hours to produce 1 unit LED & 20
labour hours to produce 1 TAB.
 China need 20 labour hours to produce 1 unit LED & 10 labour
hours to produce 1 TAB.
UMAIR FAROOQ MUGHAL

10. Production & Consumption Without Trade
LED TAB
Japan 10 5
China 5 10
Total Production 15 15
UMAIR FAROOQ MUGHAL
 Explanation:
 If Japan uses 100 labour hours to produce LED then he
produces 10 units of LED & he uses remaining 100 labour hours
to produce TAB then he produces 5 units of TAB.
 If China uses 100 labour hours to produce LED then he
produces 5 units of LED & he uses remaining 100 labour hours
to produce TAB then he produces 10 units of TAB.

11. Production with Specialization
LED TAB
Japan 20 0
China 0 20
Total Production 20 20
UMAIR FAROOQ MUGHAL
 Explanation:
 According to specialization if Japan uses all resources for
production of LED he produces 20 units of LED & no TAB.
 China with its specialization in TAB produces 20 units TAB by
using 200 labour hours.

12. Consumption After Japan Trades 6 Units of LED for 6 Units of China TAB
LED TAB
Japan 14 6
China 6 14
UMAIR FAROOQ MUGHAL
 Explanation:
 This schedule shows that consumption after trade of 6 units of
Japan LED in return of 6 units of China TAB.

13. Increase in Consumption as a Result of Specialization & Trade
LED TAB
Japan 4 (14 -10) 1 (6 - 5)
China 1 (6 – 5) 4 (14 – 10)
UMAIR FAROOQ MUGHAL
 Explanation:
 This schedule shows that increase in consumption as a result of
specialization. Japan produces 20 units of LED with specialization
& he need only 10 units after trade 6 Units of LED, 4 units
remaining it is an Absolute Advantage.
 This schedule shows that increase in consumption as a result of
specialization. China produces 20 units of TAB with specialization
& he needs only 10 units after trade 6 Units of TAB, 4 units
remaining it is an Absolute Advantage.

14. UMAIR FAROOQ MUGHAL
L
E
D
5
10
15
20
TAB
5 10 15 20
Y-axis
X-axis
J
J
C
C
A
B
PPF – Production
possibility Frontier.
 Explanation:
 This diagram show that if Japan use all its labour
hours to produce LED then he produce 20 units of
LED & if he use all labour hours to produce TAB then
he produce 10 TAB.
 If China uses all its labour hours to produce LED
then he produces 10 units of LED & if he use all
labour hours to produce TAB then he produce 20
TAB. The different combinations that Japan could
produce are represented by the line JJ’. This is
referred to as Japan Production Possibility Frontier
(PPF).
 I draw this curve on x-axis & y-axis. At 5 & 10 curve
is join that is show the two countries production &
consumption that is show from A & B. The different
combinations that China could produce are
represented by the line CC’. This is referred to as
China Production Possibility Frontier (PPF).
 Clearly Japan has an absolute advantage in LED
because he produces 20 LED by using 200 labour
hours & China has an absolute advantage in TAB
because he produce 20 TAB using 200 labour hours
as compare to Japan.

15. UMAIR FAROOQ MUGHAL
 Definition:
 ‘’A person or country who produce a good on lower
opportunity or labour cost that is called comparative
advantage’’
 The theory of comparative advantage (1817) – David Ricardo asked
what happens when one country has an absolute advantage in the
production of all goods.
 A trade theory which holds that nations should produce those goods for
which they have the greatest relative advantage.
 The theory of comparative advantage (1817) - countries should
specialize in the production of those goods they produce most
efficiently and buy goods that they produce less efficiently from other
countries.

16.  An example:
 Assume:
 Assume that two countries, Japan & China, both have 200 labour hours units
of resources that could either be used to produce LED & TAB
 Lower labour-hours per unit of production mean lower production costs and
higher productivity of labour.
 Only these two countries in the world.
 Only two products TAB & LED
 Trade 4 by 4
 Japan have comparative advantage in both goods.
UMAIR FAROOQ MUGHAL

17. Labour Hours Required to Produce 1 Unit of LED & TAB
LED TAB
Japan 10 15
China 40 20
 Explanation:
 Japan need 10 labour hours to produce 1 unit LED & 15
labour hours to produce 1 TAB.
 China need 40 labour hours to produce 1 unit LED & 20 labour
hours to produce 1 TAB.
UMAIR FAROOQ MUGHAL

18. Production & Consumption Without Trade
LED TAB
Japan 10 6.67
China 2.5 5
Total Production 12.50 11.67
UMAIR FAROOQ MUGHAL
 Explanation:
 If Japan uses 100 labour hours to produce LED then he
produces 10 units of LED & he uses remaining 100 labour hours
to produce TAB then he produces 6.67 units of TAB.
 If China uses 100 labour hours to produce LED then he
produces 2.5 units of LED & he uses remaining 100 labour
hours to produce TAB then he produces 5 units of TAB.

19. Production with Specialization
LED TAB
Japan 15 3.33
China 0 10
Total Production 15 13.33
UMAIR FAROOQ MUGHAL
 Explanation:
 According to specialization if Japan uses 150 labour hours to
produce LED then he produces 15 units of LED & if he use
remaining 50 labour hours to produce TAB then he produce
3.33 units of TAB.
 China with its specialization in TAB produces 10 units TAB by
using 200 labour hours. Because he need 20 labour hours to
produce 1 unit of TAB.

20. Consumption After Japan Trades 4 Units of LED for 4 Units of China TAB
LED TAB
Japan 11 7.33
China 4 6
UMAIR FAROOQ MUGHAL
 Explanation:
 This schedule shows that consumption after trade of 4 units of
Japan LED in return of 4 units of China TAB.

21. Increase in Consumption as a Result of Specialization & Trade
LED TAB
Japan 1 (11 -10) 0.66 (7.33 – 6.67)
China 1.5 (4 – 2.5) 1 (5 – 4)
UMAIR FAROOQ MUGHAL
 Explanation:
 This schedule shows that increase in consumption as a result of specialization or
comparative advantage. Japan produces 15 units of LED & 3.33 units of TAB with
specialization & he need only 10 units of LED after trade 4 Units of LED and 6.67 units
of TAB after receiving 4 units of TAB, 1 units of LED and 0.66 (7.33 – 6.67) unit of TAB
remaining it is an Comparative Advantage.
 This schedule shows that increase in consumption as a result of specialization. China
produces 10 units of TAB with specialization & he needs only 5 units after trade 4
Units of TAB, 1 unit remaining it is an Absolute Advantage.

22. UMAIR FAROOQ MUGHAL
L
E
D
5
10
15
20
TAB
5 10 15 2013.333.33 6.67
2.5
J
J
C
C
A
C
B
Y-axis
X-axis
PPF – Production
possibility Frontier.
 Explanation:
 This diagram show that if Japan use all its labour hours
to produce LED then he produce 20 units of LED & if he
use all labour hours to produce TAB then he produce
13.33 TAB. The different combinations that Japan could
produce are represented by the line JJ’. This is referred
to as Japan Production Possibility Frontier (PPF).
 If China uses all its labour hours to produce LED then he
produces 5 units of LED & if he use all labour hours to
produce TAB then he produce 10 TAB. The different
combinations that China could produce are
represented by the line CC’. This is referred to as China
Production Possibility Frontier (PPF).
 I draw this curve on x-axis & y-axis. At 2.5, 10 & 15 curve
is join that is show the two countries production &
consumption that is show from A, B & C.
 Clearly Japan has a comparative advantage in LED &
TAB because he produces 15 LED by using 150 labour
hours & 3.33 TAB by using 50 labour hours. In both
products Japan use minimum labour hours as compare
to China.
 China has an absolute advantage in TAB because he
produce 10 TAB using 200 labour hours as compare to
Japan.

23.  Eli Heckscher (1919) and Bertil Ohlin (1933)
 ‘’Comparative advantage arises from differences in national factor
endowments.’’
 The extent (degree) to which a country is endowed with resources like
land, labor, and capital
 The more abundant (rich) a factor, the lower its cost
 Summarize the different theories explaining trade flows between nations.
 Basic factors:
› Natural resources
› Climate
› Geographic location
› Demographics
 While basic factors can provide an initial advantage they must be
supported by advanced factors to maintain success.
 Advanced factors:
› The result of investment by people, companies, and government are more likely to
lead to competitive advantage. If a country has no basic factors, it must invest in
advanced factors.
UMAIR FAROOQ MUGHAL

24.  The Product Life Cycle-Theory is an economic theory that was
developed by Raymond Vernon.
 The product life cycle explain How trade patterns change overtime.
 1960’s, Raymond Vernon attempts to explain global trade patterns.
First, new products are introduced in the United States. Then, as demand
grows in the U.S it also appears in other developed nations, to which the U.S.
exports.
 Then other developed nations begin to produce the product as well thus
causing U.S. companies to set up production in those countries as well and
limiting exports from the U.S. Then it all happens again, but this time
production comes online in developed nations. Ultimately the U.S. becomes
an importer of the product that was initially introduced within its borders.
 Weakness – Not all new products are created in the United States. Many come
from other countries first such as video game consoles from Japan, New
wireless phones from Europe, etc. Several new products are introduced in
several developed countries simultaneously.
UMAIR FAROOQ MUGHAL

25. UMAIR FAROOQ MUGHAL
Introduction
& Growth
Stages.
MNC
Manufactures
product in
Developed
Countries;
Export to
Developing
Countries
SALES
Time
Early
Maturity:
MNC Moves
Production to
Developing
Country; Begins
Importing to
Home Country
Late
Maturity:
Developing
Country
Competitor
Exports Product
To MNC Home
Country;
Competes with
MNC Imports
Decline
Developing Country
Markets Remain
Viable Target
Markets For MNC;
MNC Home Country
Market is Diminishing

26.  The theory suggests that early in a products life-
cycle all the parts and labor associated with
that Product come from the area which it was
invented.
 After the product becomes adopted and used
in the world markets, production gradually
moves away from the point of origin.
 In some situations, the product becomes an
item that is important by its original country of
invention.
UMAIR FAROOQ MUGHAL

27. UMAIR FAROOQ MUGHAL
D
O
L
L
A
R
S
U.S
Export
Foreign
Production
Foreign
competition in
export market
Import
Competition in
U.S. market
TIME
Domestic
sales
U.S
Production
 Stage 1: Introduction
 Stage 2: Growth
 Stage 3: Maturity
 Stage 4: Decline

28.  New products are
introduced to meet
local (i.e., national)
needs, and new
products are first
exported to similar
countries, countries
with similar needs,
preferences, and
incomes.
 E.g. the IBM PCs were
produced in the US
and spread quickly
throughout the
industrialized countries.
UMAIR FAROOQ MUGHAL
 Increase in sale of
new product attracts
competitors.
 Increase of demand
in advanced
countries; exports
increase
 Further innovation in
product, cost
reduction, market
process takes place
 Shift manufacturing
to foreign countries

29.  World wide
production Export
decline.
 Large scale of
Production.
 Low cost production
shift manufacturing to
developing countries.
 Technology become
standard.
UMAIR FAROOQ MUGHAL
 Goods produce
in developing
countries and
thus advanced
countries shift
their demand to
further new
products to
developing
country.
 Original innovator
become
importer.