International Business Test 2

Mercantilism

- It is in a country's best interest to maintain a trade surplus—to export more than it

imports

• Advocates government intervention to achieve a surplus in the balance of trade

• Mercantilism views trade as a zero-sum game—one in which a gain by one

country results in a loss by another

Absolute advantage

- Country has absolute advantage in producing a product if more efficient than any

other country at producing it.

• Countries should specialize in the production of goods for which they have an

absolute advantage and then trade these goods for other goods produced by other

country.

• Country should never produce goods at home that it can buy at a lower cost

from other countries

- promoted by Adam Smith

What is comparative advantage

A country should specialize in production of those goods it produces most efficiently

(compared to other countries) and buy goods it produces less efficiently from other

countries, even if it can produce those goods more efficiently itself

- david ricardo

what is opportunity cost?

Opportunity cost = the value of the next best

alternative forgone.

• Opportunity cost of producing one good is

measured in terms of how much of the other

good must be given up to free labor for that

production

What are Factor Endowments

the amount of land, labor, capital, and entrepreneurship that a country possesses and can exploit for manufacturing.

• Comparative advantage arises from differences in national factor

endowments.

• Countries will export those goods that make intensive use of factors that are

locally abundant.

Capital abundant countries:

U.S., Germany, Japan

Labor abundance countries

China, India, Bangladesh

What is the product life cycle theory?

As a product matures, its sales location and location of production will change as demand grows, they will begin to export and as markets grow, production locations will change.

What are the stages of the product life cycle

1. Introduction

2. Growth

3. Maturity

4. Decline

What are economies of scale?

Economies of scale occur when the average cost per unit of output decreases

as the firm increases its production volume.

- producing more of the same product makes it cheaper per unit.

What is New Trade Theory?

Suggests ability of firms to gain Economies of Scale and first mover advantage.

What are first-mover advantages?

Economic and strategic advantages that go to the first to enter a market.

✓ Can gain a scale-based cost advantage that is hard for later entrants to match.

what are the implications of new trade theory?

✓ Nations may benefit from trade even when they do not differ in resource endowments

or technology.

✓ Argues for government intervention and strategic trade policy.

What is Porter's Diamond

- Factor endowments

- Demand conditions

- Related and supporting industries

- Structure of firms and strategy

- also important: chance & government

What are specific tariffs?

levied as a fixed charge for each unit of a good imported

What are ad valorem tariffs?

levied as a proportion of the value of the imported good

what are the impact of import tariffs?

Increase government revenues.

• Reduce competition faced by domestic producers (decreasing

downward pressure on prices).

• Consumers pay more for certain imports.

• As a result, import tariffs are pro-producer and anti-consumer.

• Reduce the overall efficiency of the world economy.

What are export tariffs?

a tax placed on the export of a good.

• Goal is to discriminate against exporting in order to ensure

that there is sufficient supply of a good within a country.

What are export bans?

a policy that partially or entirely restricts the

export of a good.

What are subsidies?

Government payment to a domestic producer.

1. Cash grants.

2. Low-interest loans.

3. Tax breaks.

4. Government equity participation.

• Help domestic producers compete against foreign imports

and gain export markets.

• Domestic producers gain, consumers typically absorb

costs

What are import quotas?

direct restrictions on quantity of some

good that may be imported.

What are tariff rate quotas?

provide a lower tariff rate to imports

within the quota than those over the quota.

What is a Voluntary export restraint (VER)?

a quota on trade

imposed by the exporting country.

What is quota rent?

refers to the extra profit producers make when

supply is artificially limited by an import quota.

what are local content requirements?

• Some fraction of a good must be produced locally.

• Expressed in either physical or value terms.

• Protects domestic producers.

• Consumers face higher prices.

What is dumping?

Dumping = when companies sell goods in a foreign market at below their costs of

production or below their "fair" market value; its a way to unload excess production

What are antidumping policies?

punish foreign firms that engage in dumping and protect domestic producers from "unfair" foreign competition

What are the political arguments FOR government intervention?

- protecting jobs and industries

- protecting national security

- retaliation

- protecting consumers from unsafe products

What is the infant industry argument

support new industries until they

have grown strong enough to meet international competition.

• Support comes through tariffs, import quotas, subsidies.

two criticisms:

1. Protection of manufacturing from foreign competition does no good unless the protection

helps make the industry efficient.

2. Assumes firms are unable to make efficient long-term investments by borrowing money

from the domestic or international capital market

What is strategic trade policy?

Government can help raise national income when a domestic firm gains first-

mover advantages.

• Might pay for a government to intervene in an industry by helping domestic

firms overcome the barriers to entry created by foreign firms that have

already reaped first-mover advantages.

• Both arguments support government intervention in international trade.

What is GATT

General Agreement on Tariffs and Trade; designed to liberalize trade by eliminating tariffs, subsidies, import quotas, etc.

What is the Uruguay Round?

• Extend GATT rules to cover trade in services.

• Develop rules on intellectual property.

• Reduce agricultural subsidies.

• Strengthen GATT's monitoring and enforcement.

What is the World Trade Organization?

An international organization that ensures that the terms of the GATT are carried out

What does the current agenda of the WTO focus on?

1. The rise of anti-dumping policies.

2. The high level of protectionism in agriculture.

3. The lack of strong protection for intellectual property rights in many nations.

4. Continued high tariffs on nonagricultural goods and services in many nations.

What is protectionism in agriculture?

• Tariff rates generally much higher on agricultural products.

• Reflects desire to protect domestic agriculture and traditional farming communities.

• Net effect is to raise consumer prices

What are FDI flow and FDI stock?

FDI Flow—FDI amount invested over given period.

FDI Stock—total accumulated value of foreign-owned assets at a given time.

Acquisition vs. greenfield investments

• A greenfield investment establishes a new operation in a

foreign country.

• Acquire or merge with an existing company. (Quicker to execute, can acquire valuable strategic assets, can increase the efficiency of the acquired unit)

What is Liability of Foreignness (LoF)?

additional costs and disadvantages that firms face when operating outside their home country compared to local firms (Zaheer, 1995).

What are the limitations of FDI?

FDI is expensive and risky compared with exporting and licensing

Why FDI?

Exporting has limitations: Transportation costs and trade barriers.

• Value-to-weight ratios

What is value-to-weight ratio?

how much value (in monetary terms) a

product contains relative to its physical weight; high value-to-weight ratio means the product is valuable but

lightweight (e.g., microchips, luxury watches, pharmaceuticals).

• low value-to-weight ratio means the product is bulky but low in value (e.g., cement, steel, furniture)

What are the limitations of licensing?

May result in firm giving away valuable technological know-how to potential

foreign competitor. RCA in Japan

• Does not give a firm the tight control over production, marketing, and strategy in a foreign country that may be required to maximize its

profitability. - Threat of competitors

• Not good if the firm's competitive advantage is based on the management, marketing, and manufacturing capabilities. - Toyota

What is multipoint competition?

when two or more enterprises encounter each other in different regional markets, national markets, or industries

What is the eclectic paradigm

Argument that combining location-specific assets or resource endowments and the firm's own unique assets often requires FDI; it requires the firm to establish production facilities where those foreign assets or resource endowments are located.

What is the OLI eclectic paradigm?

FDI will occur only if all three advantages are present:

1. O (Ownership) - The firm must possess unique, transferable assets

or capabilities that provide an advantage abroad.

2. L (Location) - The target country must offer location-specific

incentives (e.g., lower costs, resource access, new markets).

3. I (Internalization) - The firm must find it more efficient or secure to

exploit its ownership advantages through direct control (FDI) rather

than through licensing or exporting.

What is pragmatic nationalism?

FDI has both benefits (inflows of capital, technology, skills and jobs) and costs (repatriation of profits to the home country and a negative balance of payments effect).

What are the benefits of FDI for host countries?

Resource-Transfer Effects: Supplies capital, technology, management resources.

Employment Effects: Brings jobs to a host country that would otherwise not be created there.

• May be offset by loss of jobs in home country.

• Effect on Competition and Economic Growth (increases competition)

What is BOP and its three main accounts

Systematic record of all economic transactions between residents

of a country and the rest of the world during a specific period (usually a year)

1. Current Account — records trade in goods and services, income, and

unilateral transfers (remittances).

2. Capital Account — records capital transfers and acquisition/disposal of

non-produced, non-financial assets (minor component).

3. Financial Account — records investment flows (e.g., FDI, portfolio

investment, reserve assets)

What are the costs of FDI to the host country?

1. Adverse effects of FDI on competition

2. Adverse effects on the balance of payments

3. Perceived loss of national sovereignty and autonomy

What are the home-country benefits & costs of FDI

Home-Country Benefits

• The home country's balance of payments benefits from the inward flow of foreign earnings.

• Employment effects.

• Reverse resource-transfer effect.

• MNE learns valuable skills from its exposure to foreign markets that can subsequently be transferred back to the home country.

Home-Country Costs

• Balance-of-payments effects suffer in three ways:

• Initial capital outflow needed to finance FDI.

• The current account of the balance of payments suffers if the purpose of the foreign investment is to serve the home market from a low-cost production location.

• The current account of the balance of payments suffers if the FDI is a substitute for direct exports.

What is a free trade area?

• Eliminates all barriers to the trade of goods and services among

member countries.

• Each country allowed to determine its own trade policies regarding

nonmembers.

• NAFTA and USCMA.

What is a customs union?

• Builds on a Free Trade Area by adding a common external tariff (CET) — all members apply the same tariff rates to non-members.

• The EU began as a customs union

What is a common market?

Extends a customs union by allowing free movement of

factors of production — labor, capital, and services — across member states.

• No restrictions on immigration, emigration, or cross-border flows of capital among member countries.

• Requires harmony and cooperation on fiscal, monetary, and employment policies.

• Has proved very difficult

What is Economic union?

• A common market with common currency and harmonized

economic policies (fiscal, monetary, and regulatory).

• Requires a high degree of integration, a coordinating

bureaucracy, and the sacrifice of national sovereignty to the bureaucracy

What is political union?

• Central political apparatus coordinates economic, social,

and foreign policy of member states.

• EU headed toward at least partial political union, and the

U.S. is an even closer example of political union.

What is the economic case for integration

• All countries gain from free trade and investment—a positive-

sum game.

• Motivated by desire to exploit gains from free trade and

investment

What is the political case for integration

-Linking countries together, making them more dependent on each other, promotes political cooperation

-Reduces the likelihood of violent conflict

-Gives countries greater political clout when dealing with other nations

What is trade creation?

FTA allows imports from a more efficient member instead of domestic

production

What is trade diversion?

FTA shifts imports from a more efficient non-member to a less

efficient member

What is the case against regional integration?

Regional economic integration is only beneficial if the

amount of trade it creates exceeds the amount it diverts.

• Trade creation.

• Trade diversion.

What is NAFTA

Free trade area among Canada, Mexico and the U.S.

• Abolished tariffs on 99 percent of goods traded between members.

• Removed barriers on the cross-border flow of services.

• Protects intellectual property rights.

How do Mexico, the U.S., and Canada benefit from NAFTA

• Mexico would benefit from:

• Increased jobs as low cost production moves south and more rapid

economic growth as a result.

• U.S. and Canada would benefit from:

• Access to a large and increasingly prosperous market.

• Lower prices for consumers from goods produced in Mexico.

What is the USMCA

Introduces strong digital trade rules ensuring free data flows, data localization limits, and protections for e-commerce.

- Automotive Rules of Origin

- Agricultural Market Access

What are the two trade blocs of Europe?

EU and EFTA

What is the single European Act?

• Remove all frontier controls among EC countries.

• Apply the principle of "mutual recognition" to product standards.

• Institute open public procurement to non-national suppliers.

• Lift barriers to competition in the retail banking and insurance

businesses.

What is Brexit?

Britain's exit from the EU

What is the Heckscher-Ohlin Theory

The Heckscher-Ohlin Theory says countries export goods that use their abundant factors of production and import goods that use their scarce factors. It emphasizes how comparative advantage arises from factor endowments.

What is the Leontief Paradox

The Leontief Paradox is a finding that suggests that the United States, which was thought to be abundant in capital, exported more labor-intensive goods and imported more capital-intensive goods, contradicting the Heckscher-Ohlin theory.

What is knickerbockers’s theory of strategic behavior?

Explains how firms consider the actions and reactions of competitors when making decisions about foreign direct investment and market entry strategies, emphasizing that strategic moves are interdependent.