5 International Trade Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

5 - 2 Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall International Trade Purchase, sale, or exchange of goods and services across national borders People have larger selection of products Important engine for job creation

5 - 3 Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Trade and World Output World trade 80% merchandise 20% services World output impacts trade Growing output = growing trade Sluggish output = sluggish trade World trade grows faster than world output

5 - 4 Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall World’s Top Exporters

5 - 5 Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Trade Patterns Merchandise trade among: Low- and middle-income nations High-income nations High-income and low- and middle-income nations

5 - 6 Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Who Trades with Whom?

5 - 7 Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Trade Dependence and Independence Potential effects of dependence: + Infuses needed capital + Creates jobs and raises wages + Imports technology and skills – Economic problems transferred – Political turmoil can spill over Total dependence Total independence

5 - 8 Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Trade Theory Timeline

5 - 9 Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Foundations of Mercantilism Nations accumulate financial wealth by encouraging exports and discouraging imports Three pillars: ▪ Maintain trade surplus ▪ Government intervention ▪ Exploit colonies

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Flaws of Mercantilism ‒ World trade is a zero-sum game ‒ Limits colonies’ market potential ‒ Constrains output and consumption

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Absolute Advantage Ability of a nation to produce a good more efficiently than any other nation (greater output using same or fewer resources) Specialization and trade allows each to produce and consume more 1 resource unit = 1 ton rice or 1/5 ton tea Riceland 1 resource unit = 1/6 ton rice or 1/3 ton tea Tealand

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Trade Gains: Absolute Advantage Specialization and trade: + Riceland gets five times more tea than it would have produced itself + Tealand gets two times more rice than it would have produced itself

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Comparative Advantage Inability of a nation to produce a good more efficiently than other nations, but an ability to produce that good more efficiently than it does any other good Specialization and trade allow each to produce and consume more 1 resource unit = 1 ton rice or 1/2 ton tea Riceland 1 resource unit = 1/6 ton rice or 1/3 ton tea Tealand

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Trade Gains: Comparative Advantage Specialization and trade: + Riceland gets two times more tea than it would have produced itself + Tealand gets two times more rice than it would have produced itself

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Assumptions and Limitations Nations strive only to maximize production and consumption Only two countries produce and consume just two goods No transportation costs of traded goods Labor is the only resource used to produce goods Ignores efficiency and improvement gains from producing just one good

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Discussion Question When a nation cannot produce a good more efficiently than other nations, but it can produce that good more efficiently than it does any other good, we say this is a case of __________. a. Absolute advantage b. Comparative advantage c. Mercantilism

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Answer to Discussion Question When a nation cannot produce a good more efficiently than other nations, but it can produce that good more efficiently than it does any other good, we say this is a case of __________. a. Absolute advantage b. Comparative advantage c. Mercantilism

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Factor Proportions Theory Countries produce and export goods that require resources (factors) in abundance, and import goods that require resources in short supply Two factor types Land and Capital Labor

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Leontief Paradox Research found evidence opposite of that predicted by the factor proportions theory: U.S. exports are more labor-intensive than U.S. imports Possible explanations: Theory assumes nation’s production factors to be homogeneous Theory is better predictor when expenditures on labor are considered

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall International Product Life Cycle A company begins by exporting its product and later undertakes foreign direct investment as a product moves through its life cycle Source: Raymond Vernon and Louis T. Wells, Jr., The Economic Environment of International Business, 5 th ed. (Upper Saddle River, N.J.: Prentice Hall, 1991), p. 85.

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall New Trade Theory Fundamentals  Gains from specialization and economies of scale  Companies first to market create barriers to entry  Government may help by assisting home companies First-mover advantage  Economic and strategic advantage of being first to enter an industry  May create a formidable barrier to market entry for potential rivals

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall National Competitive Advantage Nation’s competitiveness in an industry depends on the industry’s capacity to innovate and upgrade, which in turn depends on four main determinants (plus government and chance) Nation’s competitiveness in an industry depends on the industry’s capacity to innovate and upgrade, which in turn depends on four main determinants (plus government and chance) Factor conditions Demand conditions Firm strategy, structure, and rivalry Related and supporting industries

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Factor Conditions Basic Factors Advanced Factors

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Demand Conditions Sophisticated home-market buyers drive companies to improve existing products and develop entirely new products and technologies This should improve the competitiveness of the entire group of companies in a market

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Related and Supporting Industries Companies in an internationally competitive industry do not exist in isolation Supporting industries form “clusters” of economic activity in the geographic area Each industry reinforces the competitiveness of every other industry in the cluster

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Firm Strategy, Structure, and Rivalry  Highly skilled managers are essential because strategy has lasting effects on firm competitiveness  Domestic industry whose structure and rivalry create an intense struggle to survive strengthens competitiveness

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Discussion Question National __________ theory states that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade. a. Product life cycle b. First-mover c. Competitive advantage

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Answer to Discussion Question National __________ theory states that a nation’s competitiveness in an industry depends on the capacity of the industry to innovate and upgrade. a. Product life cycle b. First-mover c. Competitive advantage