Chapter 5
Learning Objectives
Factors explaining international trade
patterns
Differences in productivity
Differences in factor endowment
International product life-cycle
Economies of scale
National competitive advantage
Learning Objectives
Implications for business suggested by
each of the theories
Cost of production
Low cost location
First mover advantage
Resource allocation
Government policy
Chapter Focus
Review several trade theories that explain why it
is beneficial for a country to engage in
international trade.
Explain the pattern of international trade
observed in the world economy.
Chapter 4
International Trade Theory
Various explanations are given to rationalize the observed patterns of international
trade.
Adam Absolute Advantage Free Trade,
Smith Least Govt.
Intervention
David -Comparative Advantage Unrestricted Free
Ricardo Trade
-Gains from trade arising Increase in World
from differences in Production
productivity
Hecksher- Comparative Advantage Free Trade
Olin Theory arises from differences in Beneficial
National Factor
Endowments
Absolute Advantage
250
200
150
Cocoa
Ghana
100 South Korea
50
0
0 50 100 150 200 250
Rice
Ghana [Link]
Cocoa=10 res./unit Cocoa=40 res./unit
Rice=20 res./unit Rice=10 res./unit
Ghana has an absolute advantage in cocoa and
S. Korea has an absolute advantage in rice.
Absolute Advantage (cont)
Effect of Trade: Increase Total Production
Increase Total Consumption
Specialization
Trade is a positive sum game
PPF
Comparative Advantage
Differences in Labor Ghana- more efficient in both
cocoa and rice
Productivity Absolute advantage in both, but has
a comparative advantage in cocoa.
It produces 4 times as much cocoa
G as [Link], but 1.5 times as much
rice.
Why should Ghana trade?
Total Production
K
Total Consumption
K’
G’
Heckscher-Olin Theory
Comparative Advantage arises from differences in
national factor endowments.
Countries export the products that use the resources
or factors that are abundant.
Leontief’s Paradox
How do you explain:
The U.S. exports commercial aircrafts and imports
automobiles?
1. The Product Life Cycle Theory
New products introduced in the U.S. and exported to advanced
countries.
Overtime, as demand increases advanced countries produce for
their home markets. Also, the U.S. firms set up production facilities
in advanced countries
U.S. exports are limited
As the market in the U.S. and other advanced countries matures,
the product becomes more standardized. Cost considerations play
an important role. Countries with lower cost (Italy, Spain) export to
the U. S.
Developing Countries like Thailand start acquiring cost advantage
factories
Exports from Thailand (pg. 136 chart)
2. New Trade Theory
Paul Krugman (M. I. T.) developed a new trade theory:
“Countries specialize in the production and export of products not
because of factors endowments but because in some industries
world market can support only a limited number of firms”
First-mover advantage:
The firm builds a competitive advantage by being the first (Boeing
in com. Jet aircraft). Other countries with similar factor
endowment find it difficult to produce.
Specialization, economies of scale and demand conditions
Role for subsidies or selective government intervention
3. Porter’s Diamond
Michael Porter of Harvard Business School published a book in 1990:
Competitive Advantage of Nations
Why does a country achieve international success in a particular industry?
Ex. Japan —Automobiles
Switzerland—Precision Instruments
U.S.A. —Chemicals
H/O Theory cannot explain some of these patterns—partial explanation
Four attributes create or impede competitive advantage:
1. Factor Endowments
2. Demand Conditions
3. Related and Supporting Industries
4. Firm Strategy, Structure and Rivalry
Two additional Factors:
Chance—opportunities
Government—Anti-trust policy, Inv. In Education