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Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
USEU
Australia
China
Chapter 3: International Trade Theory
Comparative
advantage New TradeTheory
3-1
Absoluteadvantage
Absoluteadvantage
PORTER’S DIAMOND
FACTOR
ENDOWMENTS
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
TOPIC PLAN:
Mercantilism Absolute advantage Comparative advantage Comparative advantage versus competitive
advantage Factor endowments The New Trade Theory Porter’s Diamond
3-2
Mercantilism: mid-16th century
A nation’s wealth depends on accumulation of precious metals (e.g. holdings of gold and silver).
Theory says you should have a trade surplus. » Maximize exports through subsidies.» Minimize imports through tariffs and quotas.
David Hume (1752): persistent trade surplus will affect the money supply and in the long run close the trade surplus
Key problem: “Zero-sum game”.
3 - 3
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
Theories of International Trade:Absolute Advantage
The exporting country holds a superiority in the availability of certain goods. Reasons:» Climate,quality of land, and natural resources.» Differences in labour, capital, technology and
entrepreneurship Beef Computer Printers (tonnes) (units) Australia 800 200 Japan 400 500• Australia has an absolute advantage in beef, while
Japan has an absolute advantage in printers.
.
3 -4
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
Theory of Comparative Advantage
David Ricardo (1817) One country has a comparative
advantage over another in the production of a certain commodity if its opportunity cost of producing that commodity is lower
3.5
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
Alternative production possibilities
from 100 units of resources
Commodity Country
Cheese (tonnes)
Cloth (bolts)
Australia 200 160
U.K. 80 120
3.6
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
Opportunity Cost and Comparative Advantage
Production Australia U.K
1 tonne of cheese
0.8 bolts of cloth
1.5 bolts of cloth
1 bolt of cloth
1.25 tonne of cheese
0.67 tonnes of cheese
3.7
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
Diversified production before trade
Production/Consumption
Resources (units)
Cloth (bolts)
Australia 100 37.5 x 1.6=60
U.K. 100 120
3.8
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
The Theory of Comparative Advantage and the Gains from Trade
Cheese (tonnes) Cloth (bolts)
Production and Consumption without Trade
Australia 125 60 U.K. 40 60
Total production 165 120Production with Trade Specialization
Australia 200 - U.K - 120
Total production 200 120Consumption after U.K. Trades 60Bolts of Cloth for 60 tons of
Australian Cheese
Australia 140 60 U.K. 60 60 Increase in Consumption as a Result of Specialization and Trade
Australia 15 0U.K 20 0
3- 9Total consumption 35 0
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
Comparative versus Competitive Advantage
Comparative advantage is a concept based on relative costs of production (and opportunity cost) between nations.
Competitive advantage is a concept used to compare two company’s ability to compete in the same business.
3- 10
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
Factor Endowments(Heckscher and Ohlin)
Explains differences in opportunity costs Factor endowment: A country’s share of factors of
production (e.g. land,capital, labour,enterprise). Countries will specialise in those goods which
make more intensive use of the abundant/cheap factors.» Cheese:land-intensive» Cloth: labour-intensive
The theory can explain the Australia-Japan trade patterns
3-11
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
Limitations of the Trade Theory
The theory disregards a number of considerations :» The difficulty in moving resources in the desired
industries» Fluctuations in demand» Trade barriers» Other political restraints
3-12
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
The New Trade Theory
Began to be recognised in the 1970s. Deals with the returns on specialisation
where substantial economies of scale are present.» Specialisation increases output, ability to
enhance economies of scale increase.» In some industries there are likely to be
only a few profitable firms.
3-13
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
The New Trade Theory
Thus firms with first mover advantages will develop economies of scale and create barriers to entry for other firms.
The commercial aircraft industry is an excellent example (eg. Boeing, Airbus)
New trade theory does NOT contradict the theory of comparative advantage, but instead identifies a source of comparative advantage
3-14
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
Implications from the application of the New Trade Theory
Typically, requires industries with high, fixed costs.
World demand will support few competitors. Competitors may emerge because “they got there
first”» first-mover advantage.
Some argue that it generates government intervention and strategic trade policy (e.g. the need to nurture and protect “first movers”)
3-15
National Competitive Advantage:
Porter’s Diamond(Harvard Business School, 1990)
Looked at 100 industries in 10 nations.» Thought existing theories didn’t go far enough.
Results contained in The Competitive Advantage of Nations.
Question: “Why does a nation achieve international success in a particular industry?” (e.g. Switzerland in Watches and Pharmaceuticals; Finland in Mobile Phones)
3-16
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
Determinants of National Competitive Advantage
Firm StrategyStructure, andRivalry
Related and Supporting Industries
Demand Conditions
Factor Endowments
Government
Chance
3-17
The Diamond
Success occurs where these attributes exist.» More/greater the attribute, the higher
chance of success. The four attributes, government policy and
chance work as a reinforcing system. Nokia is a good example of a firm which
has built its competitive advantage as a result of factors in Porter’s diamond.
3-18
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
Evaluating Porter’s Theory
If Porter is right, his model is expected to predict the pattern of international trade in the real world:» a country’s exports should reflect the
presence of the four ‘diamond’ components. » Countries will import in those areas where
the components are not favorable. This theory is too new. Requires independent
empirical testing.
3-19
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/aInternational Trade and Investment by John Gionea
Slides prepared by John Gionea
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