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 Adam Smith Absolute AdvantageFree Trade, Least Govt. Intervention David Ricardo -Comparative Advantage -Gains from trade arising from differences in productivity Unrestricted Free Trade Increase in World Production Hecksher- Olin Theory Comparative Advantage arises from differences in National Factor Endowments Free Trade Beneficial International Trade Theory Various explanations are given to rationalize the observed patterns of international trade.

Absolute Advantage GhanaS.Korea Cocoa=10 res./unitCocoa=40 res./unit Rice=20 res./unitRice=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

Comparative Advantage Differences in Labor Productivity G G’ K K’ Ghana- more efficient in both cocoa and rice Absolute advantage in both, but has a comparative advantage in cocoa. It produces 4 times as much cocoa as S.Korea, but 1.5 times as much rice. Why should Ghana trade? Total Production Total Consumption

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