IB Exam 2

International trade allows a country 

• to specialize in the manufacture and export of products and services that it can produce efficiently

• import products and services that can be produced more
  efficiently in other countries

• This economic argument is difficult to accept for
  domestic producers –
  • want limits on imports

Mercantilism

• country maintain a trade surplus

• government intervention needed to achieve a surplus

• views trade as a zero-sum game

Adam’s Smith Theory of Absolute Advantage

Countries:

• differ in their ability to produce goods efficiently

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

• trade these goods for goods produced by other countries

• trade is a positive sum game  

Ricardo’s Theory of Comparative Advantage

specialize in the production of those goods that it produces most efficiently and buy the goods that it produces less efficiently from other countries

• even if it can produce those goods more efficiently itself

• total output is higher, both countries benefit

• trade is a positive sum game

Ricardo’s Theory of Comparative Advantage Critiques

• overly simplistic

• makes too many assumptions:

  • two countries and two goods

  • zero transportation costs

  • similar prices and values

  • mobile resources 

Unrestricted Free Trade

• beneficial - raises economic welfare 

• a country’s stock of resources is increased

• greater efficiency of resource utilization and so resources are freed up for other issues

• gains may not be as great bc:

  • immobile resources

  • diminishing returns 

Immobile resources

resources don’t shift so easily from producing one good to another

diminishing returns

more units of resources are required to produce each addition unit

Hecksher-Ohlin Theory

pattern of trade is determined by factor endowments

Countries:

• export goods that are locally abundant factors

• import goods that are locally scarce 

Assumption: technologies are the same across countries

• preferred be economists

• predictive power is lower than Ricardo’s theory of Comparative Advantage 

Paul Krugman New Trade Theory

• intra-industry trade

• suggests that trade allows firms to gain economies of scale

  • trade can increase the variety of goods 

• Countries may specialize in the production and export of particular products

  • because in certain industries, the world market can only support a limited number of firms  

New Trade Theory (1)

(1) Trade increases the variety of goods available to consumers and helps decrease the average costs of those goods 

Without trade- nations might not be able to produce those products where economies of scale are important

With trade - markets are large enough to support the production necessary to achieve economies of scale 

New Trade Theory (2) 

(2) when output required to attain economies of scale represents a significant proportion of total world demand

• first movers can gain a scale based cost advantage that later entrants find difficult to match

• first mover advantages - the economies and strategic advantages that accrue to early entrants into an industry 

What are the implications of new trade theory for nations

• Trade increases specialization of production within an industry

• Increases the variety of products available to
  consumers

• Results in lower average prices of products

• Government’s strategic trade policies could

  • nurture and protect firms and industries where first
    mover advantages and economies of scale are
    important (Boeing, Airbus)

• Nations may benefit from trade even when they do not differ in resource endowments or technology

  • First mover advantages
    

Raymond Vernon Product Life Cycle Theory 

proposed an alternative explanation for international trade patterns, based on product life-cycles

• Size and wealth of US market gave US firms an incentive to develop new products

• Initially the product would be produced and sold in US

• As demand grows,  US firms -> export to other countries

• Over time, U.S. firms might establish production abroad

• As product matures, cost pressures are intense, production is done in lower-cost foreign locations and US -> imports the products

Does the product life style theory hold?

Explains some trade patterns

•Especially for products like Xerox photocopiers, TVs, PCs etc.

•That were developed in the United States in twentieth century

 

•But, this theory less valid today

•production today is dispersed globally

•many new products are now introduced in Japan (videogame consoles) or Europe (new wireless phones)

•products today are introduced in multiple markets simultaneously

Porter’s Diamond of Competitive Advantage

1. Factor Endowments

2. Demand conditions

3. Related and supporting industries

4. firm strategy, structure, rivalry

Factor Endowments

- a nation’s position in factors of production necessary to compete in a given industry

 

•can lead to competitive advantage

 

•can be either: Basic

•Brings initial advantages

•Example: natural resources, climate, location

 

• or Advanced

•Product of investment by individuals, companies and government

•Example: skilled labor, infrastructure, technological know-how

Demand Conditions

the nature of home demand for the industry’s product or service

 

•influence the development of capabilities

•sophisticated and demanding customers pressure firms to be competitive (ex: Japan -> cameras)

Relating and supporting industries

the presence or absence of supplier industries and related industries that are internationally competitive (path dependency)

 

•US semiconductor industry -> later success in PCs and electronic products

•Switzerland dye industry -> later success in pharmaceutical industry

•can spill over and contribute to other industries

Firm strategy, structure, and rivalry

the conditions governing how companies are created, organized, and managed, and the nature of domestic rivalry

•different management ideologies affect the development of national competitive advantage

•German and Japanese firms TMTs ~ engineers

•TMTs in US ~ ?

•vigorous domestic rivalry creates pressures

•to innovate,

•to improve quality,

•to reduce costs, and

•to invest in upgrading advanced features  

Additional Ideas to Porter’s Diamond

1. Innovations

2. Government Policies