9f-trade theoriesPresentation1

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Theories of International Tradeand Investment



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Foundation Concepts

Comparative advantage Superior features of a country that

provide it with unique benefits in

global competition – derived fromeither national endowments ordeliberate national policies

Competitive advantage

Distinctive assets or competencies of a firm – derived from cost, size, orinnovation strengths that aredifficult for competitors to replicate

or imitate



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Perspectives of the Nation and the Firm

Comparative advantageIs the concept that helps answer the

question of all nations can gain andsustain national economic superiority

Competitive advantageIs the concept that helps explain how

individual firms can gain and sustain

distinctive competence vis-à-viscompetitors



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Examples of National ComparativeAdvantage

China is a low labor cost production base

India’s Bangalore region offers a critical massof IT workers

Ireland’s repositioning enabled a sophisticatedservice economy

Dubai, a previously obscure Emirate, has beentransformed into a knowledge-basedeconomy



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Examples of Firm Competitive Advantage

Dell’s prowess in global supply chainmanagement

Nokia’s design and technology leadership intelecommunications

Samsung’s leadership in flat-panel TV Herman Miller’s design leadership in office furniture (e.g., Aeron chairs)



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Why Nations Trade: Classical Theories

Mercantilism: the belief that nationalprosperity is the result of a positive balanceof trade – maximize exports and minimizeimports

Absolute advantage principle: a countryshould produce only those products in whichit has absolute advantage or can produceusing fewer resources than another country



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EXAMPLE



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Why Nations Trade: Classical Theories

Comparative advantage principle: it isbeneficial for two countries to trade even if one has absolute advantage in theproduction of all products; what matters isnot the absolute cost of production but therelative efficiency with which it can producethe product

By specializing in what they produce best andtrade for the rest, countries can use scarce

resources more efficiently



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Limitations of Early Trade Theories

Do not take into account the cost of international transportation

Tariffs and import restrictions can distorttrade flows

Scale economies can bring about additionalefficiencies When governments selectively target certain

industries for strategic investment, thismay cause trade patterns contrary to

theoretical explanations Today, countries can access needed low-costcapital on global markets

Some services do not lend themselves tocross-border trade



Absolute Advantage-

practicalities



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Introduction

By using the supply and demanddiagram this eg makes a first step inhelping you to answer these questions –

Why does a country export a particulargood?

– Why does it import a particular good?

– What forces are behind the expansion of world trade that is occurring in theworld economy?

Absolute advantage – Possibility that, due to differences in

supply conditions, one country canproduce a product at a lower price than



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A Domestic Rice Market



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Supply and Demand in aDomestic Market

Throughout the world, rice is exchanged inmarkets

Supply curve is upward sloping—firmssupply more rice to the market as the

price increases – Changes in price are represented in the

diagram by movements along the supplycurve—changes in quantity supplied

– Reductions in input prices and improvements

in technology shift the supply curve to theright

– Increases in input prices and technologysetbacks shift the supply curve to the left Known as changes in supply



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Demand curve is downward sloping—consumers demand less rice frommarket as price increases

Changes in price are represented bymovements along the demand curve—changes in quantity demanded

Additional demand-side factors

Incomes and preferences Increases shift demand curve to right Decreases shift demand curve to left

Shifts are known as changes in demand



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Intersection of supply and demand curvesdetermines the equilibrium in the domesticrice market

Any shifts will change equilibrium price and

quantity for rice by shifting the demand orsupply curves.

Rice markets are international Cannot analyze them effectively using Figure



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Absolute Advantage

Rice is produced in both Vietnam and Japan

Assume demand conditions are exactlythe same in both countries

– Implies demand curves for rice in the twocountries are exactly the same

Trade often arises due to differences insupply conditions – Assume supply curve for Vietnam is

farther to the right than supply curvefor Japan At every price Vietnam supplies more rice

than Japan – Perhaps Vietnam uses superior technology or

production inputs are lower in Vietnam



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Demand for Rice in Vietnamand Japan



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Absolute Advantage in theRice Market



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Autarky Price

Since no trade is involved between Vietnamand Japan These two prices are known in international

economics as autarky prices

Autarky is a situation in which a country has noeconomic relationships with other countries Figure depicts a situation in which autarky price

of rice is lower in Vietnam than in Japan Vietnam has an absolute advantage in the

production of rice vis-à-vis Japan



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International Trade

Absolute advantage implies a potentialpattern of trade If the two countries forgo autarky and begin to

trade

World price of rice will lie somewhere betweenthe two autarky prices, or PV < PW < P J

This situation is depicted in Figure



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Trade in the Rice Market



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A Schematic View of Absolute Advantage



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A Question

What ensures that the amount exported byVietnam is the same as the amountimported by Japan? – If EV were smaller than Z J there would be

excess demand or a shortage in world market

for rice Excess demand causes price to rise As PW rose, exports of Vietnam would expand and

imports of Japan would contract until excessdemand in world market disappeared

– Similarly, if EV were larger than Z J, PW would fall

to bring world market back into equilibrium



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Summary

Differences in supply conditions amongcountries rise to complementary patterns of absolute advantage

These patterns of absolute advantage make

possible complementary patterns of international trade



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Gains from Trade

Given a pattern of absolute advantage, it ispossible for a country to give up autarky infavor of importing or exporting Japan can import rice, and Vietnam can export

rice But should a country actually do this?



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Gains from Trade in theRice Market



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Gains from Trade—VietnamWhen Vietnam moved from autarky to

exporting in the rice marketProducers experience both an increase in

price and an increase in quantitysupplied along the supply curve

Should be good for producers Figure shows an increase in producer surplus

of area A+B as a result of the movementfrom autarky to trade

Consumers experience an increase inprice and a decrease in quantitydemanded along the demand curve

Should harm consumers

Figure shows a decrease in consumer surplusof area A



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Gains from Trade—Vietnam What do these effects mean for Vietnam?

Producers have gained area A+B

Consumers have lost area A Gain to producers exceeds loss to consumers

For economy as a whole there is a net welfareincrease of area B Vietnam gains from its entry into world

economy as an exporter



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Gains from Trade—Japan

When Japan moved from autarky toimporting in the rice marketProducers experience a decrease in price

and a decrease in quantity suppliedalong the supply curve

Should harm these producers You can see in Figure 2.6 that there has been

a decrease in producer surplus of area C

Consumers experience a decrease inprice and an increase in quantitydemanded

Contribute to an increase in consumersurplus of area C + D

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