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Chapter 6: International Trade and Investment Trade: is the voluntary exchange of goods, services, assets or money between one person or organization and another • because it is voluntary both parties to to transactions must believe they will benefit from the exchange International Trade: is trade between residents of two countries • residents may be individuals firms or non profit organizations CLASSICAL COUNTRY-BASED TRADE THEORIES • these country-based theories are particularly useful for describing trade in commodities- standardized, undifferentiated goods • multinational corporations (MNCs) rose to power in the middle of the twentieth century • scholars shifted their attention to the firm!s role in promoting international trade • developed after World War II these theories are useful in describing patterns of trade in differential good for which brand name is an important component of customer!s purchase decision Mercantilism: Mercantilism: is the sixteenth-century economic philosophy • country!s wealth is measured by its holdings of gold and silver • country!s goal should be to enlarge these holdings by promoting exports and discouraging imports • export-oriented manufactured favored mercantilist trade policies such as those establishing subsidies or tax rebates, which stimulated sales to foreigners • domestic manufactures endorsed mercantilist trade policies like imposing tariffs and quotas • governmental subsidies of the exports of industries are paid by taxpayers in the form of higher taxes governmental import reactions are paid for by consumers in the form of higher prices • because domestic firms face less competition from foreign producers • modern supporters of such theory are called neo-mercantilist or protectionist Absolute advantage: • Adam Smith • father of free-market economics • mercantilist basic problem is that it confuses the acquisition of treasure with acquisition of wealth • demonstrated that mercantilism actually weakens a country because it robs individuals of the ability to trade freely and to benefit from voluntary exchanges • a country must squander its resources producing goods it is not suited to produce • inefficiencies caused by mercantilism • advocated free trade among countries as a means of enlarging a country!s wealth enables a country to expand the amount of goods and service available • Theory of absolute advantage: suggest that a country should export those goods and services for which it is more productive than other countries are import those goods and services for which other countries are more productive than it is Comparative Advantage: Theory of comparative advantage: which states that a country should produce and export those goods and services for which it is relatively more productive than other countries are and import those goods and services for which other countries are relatively more productive than it is • difference between the two theories is subtle: • absolute advantage looks at absolute productivity differences • comparative advantage looks at relative productivity differences • distinction occurs because comparative advantage incorporates the concept of opportunity cost in determining which good a country should produce Opportunity cost: is the value of what is govern up to get the particular good in question Relative Factor Endowments: • Theory of relative factor endowments is now often referred to as Heckscher-Ohlin theory. Two major observations: 1. Factor endowments (or types of resources) vary among countries 2. Goods differ according to the types of factors that are used to produce them • tested empirically after World War II by economist Wassily Leontief using input-output analysis • used a mathematical technique for measuring the internationalships among the sectors of an economy • Leontief believed the United States was a capital abundant and labor-scarce economy • according to the Heckscher-Ohlin theory • United States should export capital-intensive goods • Leontief used his input-output model of the US economy to estimate the quantities of labour and capital needed to produce “bundles” of US exports and imports worth $1 million in 1947 • each bundle was weighted average of all US exports or imports • determined that US factories (that produce exports) were more labour intensive than US imports • US imports were more capital intensive than US exports • results were not consistent with the predictions of Heckscher-Ohlin theory • This created the Leontief paradox • Leontief assumed there are two homogenous factors of production: labour and capital • Yet other factors of production exist, most notably land human capital and technology MODERN FIRMS-BASED TRADE THEORIES • firm based theories have developed for several reasons 1. the growing importance of MNCs in the postwar international economy 2. the inability of the country-based theories to explain and predict the existence and growth of intra-industry trade (defined in the next section 3. the failure of Leontief and other researchers to empirically validate the country- based relative factor theory • incorporate factors such as quality, technology, brand names, and customer loyalty into explanations Country Similarity Theory: Inter-industry trade: is the exchange of goods produced by one industry in country A for goods produced by a different industry country B Intra-industry trade: trade between two countries of goods produced by the same industry • intra-industry accounts for 40 percent of world trade but is not predicted by country based theories • international trade in manufactured goods results from similarities of preferences among consumers in countries that are at the same stage of economic development • firm initially manufacture goods to serve the firms! domestic market • they explore exporting opportunities, they discover that the most promising foreign markets are in countries where consumer preferences resemble those of their own domestic market Country similarity theory: suggests that most trade in manufactured goods should be between countries with similar per capita incomes and the intra-industry trade in manufactured goods should be common • particularly useful in explaining trade in differentiated goods for which brand names and product reputations are important Product Life Cycle Theory: • describes the evolution of marketing strategies as a product matures, is a second firm- based theory of international trade • developed by Raymond Vernon • traces the roles of innovation, market expansion, comparative advantage and strategies responses of global rivals in international production, trade and investment decisions • consists of three stages: • new product: a firm develops and introduces an innovative product in response to perceived need in the domestic market • must closely monitor customer reactions to ensure that the new product satisfies consumer needs • quick market feedback is important • market size is also uncertain, the firm usually will minimize its investment in manufacturing capacity for the product • most output initially is sold in the domestic market • maturing product: demand for the product expands dramatically as consumers recognize its value • firm builds new factories to expand its capacity and satisfy domestic and foreign demand for the product • domestic and foreign competitors begin to emerge • standardized product: the market for the product stabilizes • product becomes more of a commodity and firms are pressure to lower their manufacturing costs as much possible by shifting production to facilities in countries with low labor • domestic production begins in stage 1, peaks in stage 2, and slumps in stage 3 • exports by the innovating firm!s country also begin in stage 1 and peak in stage 2 • by stage 3 the innovating firm!s country becomes net importer of the product Global Strategic Rivalry Theory: • firms struggle develop some sustainable competitive advantage, which they can then exploit to dominate the global marketplace • they attempt to leverage their own strengths and neutralize those of their rivals • numerous ways of obtaining a sustainable competitive advantage: • Owning intellectual property rights: • gains advantages over its competitors • charge premium prices for their upscale products • compete for customers worldwide on the basis of their trademarks and brand names • Investing in research and development: • major component of the total cost of high technology products • maintain their competitiveness • large “entry” costs, other firms often hesitate to compete against established firms • firms that acts often gains a first mover advantage • firms that invest up front and secure the first mover advantage have the opportunity to dominate the world market for goods that are intensive in R&D • trade flows may be determined by which firms make the necessary R&D expenditures • firms with large domestic markets may have an advantage over their foriegn rivals in high technology markets because these firms often are able to obtain quicker and richer feedback from customers • Achieving Economies of Scales or scope • occur when a product!s average costs decrease as the number of units produced increases • economie
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