International Trade Chapter 5

Trade Theories Mercantilism Theory of Absolute Advantage Theory of Comparative Advantage Theory of Country Size Factor-Proportions Theory Product Life Cycle Theory Competitive Advantage Theory

Theory of Country size Large countries tend to have Varied climates and an assortment of natural resources Higher domestic transportation costs for exports Economies of scale Large countries tend to have smaller degree of openness (smaller % of GDP as exports)

Factor Proportions Theory (Heckscher-Ohlin Theory) Each country specializes in products or processes which use factors in relative abundance. (e.g. Labor abundant countries: labor intensive product) Leontief Paradox: U.S,. exports are more labor intensive than U.S. imports. Paradox solved: Labor is not homogeneous (U.S. exports are of highly skilled labor contents while U.S. imports are of unskilled labor contents).

Product Life Cycle Theory (Raymond Vernon) Location of production of a product shifts internationally depending on the stage of the product life cycle. 4 stages Introduction Growth Maturity Decline

Competitive Advantage Theory (Michael Porter’s Diamond Theory) Theory explaining why a particular industry in a country gains global competitiveness. Four determining factors Factor endowments Demand conditions Supporting industries Firm’s strategy First two factors became less important with globalization

Trade Patterns Country difference theory: applicable to trade based on natural advantages Country similarity theory: applicable to trade based on acquired advantages Pairs of trading relationships Distance Cultural similarity Political and economic interests

Strategic Trading Reasons or incentives of a firm to export To utilize excess capacity To take advantage of economies of sale To spread risk by diversifying markets To increase markup Strategic trading policy of a nation General approach Specific approach