Trade Theory

International Trade Theories

An international trade theory can be seen as a measure to address problems in a country with a weak macro economy, high unemployment and inflation. International commitment to a free market economy will bring prosperity to the world economic system. Since 1970, the time of Adam Smith, economists have shown that free trade is efficient and leads to economic welfare. Mercantilism This trade theory suggested that a government can improve economic well being of the country by increasing exports and reducing imports, Absolute Advantage A country has an absolute advantage over it trading partners if it is able to produce more of a good or service with the same amount of resources or the same amount of a good or service with fewer resources. Comparative Advantage A country has a comparative advantage in the production of a good or service that it produces at a lower opportunity cost than its trading partners. Some countries have an absolute advantage in the production of many goods relative to their trading partners. Some have an absolute disadvantage. They are inefficient in producing anything, relative to their trading partners. The theory of comparative costs argues that, put simply, it is better for a country that is inefficient at producing a good or service to specialise in the production of that good it is least inefficient at, compared with producing other goods. Factor Endowment Theory - Hecksher Ohlin theory powerfully supplements the theory of comparative advantage by bringing consideration to the endowment and cost of factors of production. The theory states that countries like China with big labour force will focus on labour intensive goods, and Sweden with more capital will focus on producing goods that are capital intensive. However the theory is criticised when taken the following into consideration: 1. Other factors like minimum wage laws which leads to higher prices for relatively abundant labour - therefore making it cheaper to import rather than export. 2. Leontiff paradox The United States makes export more labour intensive, this is due to the high tech products with high labour quality input rather than man hours of work e.g. level of education will also affect a country's advantage rather than its scarcity or abundance. International Product Life-Cycle Theory (Verrons) - This theory states how a country's export can later become its import through different stages: 1. New Product stage Initial consumption in home countries where price is inelastic and profits are high, which then go on to being sold to those willing to pay a premium price. This then goes on to being exported once local consumption runs out.

2. Maturing Product stage Sales achieved through exports, and substitutes are being produced by local competitors. As substitutes come into to the market, the demand for original product will fall. The firms with the new product switch from production to market protection, and tapping markets in less developed countries. 3. Standardized Product stage Technology becomes widely diffused and available. Production shifts to low cost locations. Product becomes generic and price will become the sole determinant for demand. It is very likely that the same product may be at different stages with different versions for example cars (Japanese Toyota Avensis cars being imported into Japan). Other considerations are government regulations, monetary valuation, currency for reporting profits, consumer tastes and branding.

Adam Smith said - each nation should specialize in producing things it has an "absolute advantage" . The theory of "Absolute Advantage" seems to make sense in situations where the circumstances of the

geographic and economic environment are relatively simple and straight forward - example: Switzerland and watches, Canada and cereal grain.

The Theory of Factor Endowments suggested you should trade in the products which you can make from the production factors and resources you naturally possess. So for Canada this means we should trade in lumber and minerals and grain since we naturally possess these resources in large quantities. Following this theory it would then make sense for Canada to import citrus fruits since our climate does not naturally give us weather to allow this food to grow without expensive greenhouses. This theory was espoused by Heckscher and Ohlin.

. The Product Life Cycle

How is the PLC effected by International Business? The introduction stage can be shortened due to other competitors from around the globe copying your product, the decline stage can be extended, by exporting beyond your existing markets. The big challenges of the International Product Life Cycle these days are

1. dealing with a very short Introduction Stage, due to technological competitiveness 2. extending the length of the PLC through Market Modification

Product Modification