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.

An Overview of Trade Theory 4-2 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 easy to understand (Saudi Arabia/oil or China/crawfish). Others are not so easy to understand (Japan and cars). The history of Trade Theory and Government Involvement presents a mixed case for the role of government in promoting exports and limiting imports. Later theories appear to make a case for limited involvement. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

4-3 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/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

Theory of Absolute Advantage 4-4 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/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

Theory of Comparative Advantage 4-5 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/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

Heckscher (1919)-Olin (1933) Theory 4-6 Heckscher (1919)-Olin (1933) Theory Factor endowments: extent to which a country is endowed with such resources as land, labor, and capital. 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/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

The Leontief Paradox, 1953 Disputes Heckscher-Olin in some instances. 4-7 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/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

Product Life-Cycle Theory (Raymond Vernon, 1966) 4-8 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/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

The New Trade Theory Began to be recognized in the 1970s. 4-9 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. In addition to economies of scale, learning effects also exist. Learning effects are cost savings that come from “learning by doing”. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

First-Mover Advantage 4-10 First-Mover Advantage Economies of scale may preclude new entrants. Role of the government. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

Porter’s Diamond Determinants of National Competitive Advantage 4-11 Porter’s Diamond Determinants of National Competitive Advantage Factor Endowments Firm Strategy, Structure and Rivalry Demand Conditions Related and Supporting Industries Figure 4.6 McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.