Chapter 6

Trade theories: 

• Mercantilism (against free trade) 

  • Mercantilism makes a case for government involvement in promoting exports and limiting imports

  • In a country’s best interest to maintain a trade surplus—to export more than it imports. 

    • Gold and silver considered mainstays of national wealth. 

    • Advocated government intervention to achieve a surplus in balance of trade. 

  • Viewed trade as a zero-sum game: one in which a gain by one country results in a loss by another.

• Absolute advantage (promotes free trade)

  • A country has absolute advantage in producing a product when it is more efficient than any other country in producing it.

    • ​​Smith (1776): countries differ in their ability to produce goods efficiently. 

    • Trade is not a zero-sum game. 

    • Countries should specialize in production of goods they have an absolute advantage in and then trade these goods for goods produced by other countries.

• Comparative advantage (promotes free trade)  

  • Ricardo (1817): What happens when one country has an absolute advantage in the production of all goods? 

  • A country should specialize in production of goods that it produces most efficiently and buy goods that it produces less efficiently from other countries.

• Heckscher Ohlin (promote free trade)  

  • The Leontief Paradox Leontief (1953): Since the US was relatively abundant in capital, it would export capital-intensive goods and import labor-intensive goods. 

    • U.S. exports were less capital intensive than U.S. imports

• International product life cycle theory (dynamic changes in trade patterns)  

• Vernon (mid-1960s): proposed product life-cycle theory; based on ideas that: 

  • For most of the 20th century, majority of the world's new products were produced and sold in US market. 

  • At the time, the wealth and size of the US market gave a strong incentive for U.S. firms to develop new products.

• Product becomes standardized and price becomes the main competitive weapon.

• New trade theory (shows justification for strategic government intervention)  

  • Trade can increase variety of goods available and decrease average cost of goods. 

    • Economies of scale: unit cost reductions associated with large scale output

  • First-mover advantages: economic and strategic advantages that accrue to early entrants into an industry.

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

• Competitive advantage of nations (explains a nation's dominance in a certain industry)

  • Michael Porter’s theory of national competitive advantage: 

    • Country factors explain a nation’s dominance in the production and export of certain products.

  • Comparative advantage reflects differences in national factor endowments: extent to which a country is endowed with resources such as land, labor, and capital. 

  • Theory has common sense appeal.

    • Export goods that make intensive use of factors that are locally abundant. 

    • Import goods that make intensive use of factors that are locally scarce.

• Sample questions

  • The theory of __________ was the first to explain why unrestricted free trade benefits a country. 

    • Heckscher-Ohlin 

    • National competitive advantage 

    • Free trade 

    • Absolute advantage 

    • Zero-sum game