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Chapter 6

MGC2120 Chapter Notes - Chapter 6: Mercantilism, Leontief Paradox, Invisible Hand

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Dr Lakmal Abeysekera

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International Business Chapter 6 International Trade Theory
- Free trade: no government intervention in terms of quotas or duties. There is
the invisible hand of the market mechanism, should determine a country’s
imports and exports. => output increases, both countries are beneficial.
- Benefits of trade: common sense suggests that some trade are beneficial
a) why trade when a country can actually better producing a product by
itself? A country’s gain if citizens by products from other nations that
could be produced at home.
b) Allow a country to specialize in the manufacture and products’ exports.
c) However, sometimes difficult for a country’s population to accept.
Moreover, a whole country is hurt by such action; limits on imports
- Pattern of international trade: climate and natural resource, proportions of
factors of production available in each country.
- New trade theory suggests that some countries specialize in the product and
export of particular products because in certain industries the world market
can support only a limited numbers of firms.
Trade theory and government policy
- emerged in England in the mid-sixteen century.
- Principle assertion: gold and silver considered as currency of trade
- In a country’s best interests to maintain a trade surplus, to export more than
it imported.
- Advocated government intervention to achieve a surplus in the balance of
- Considered as a zero-sum game: which a gain by one country results in a loss
in another country.
Absolute Advantage
- it is when a country is more efficient producing a good compare to another
country producing it.
- By engaging in trade and swapping products, producers in both countries
could consume more of both products.
- Can see trade as a positive-sum game, produces net gains for all involved.
Comparative Advantage
- makes sense for a country to specialize in the production of the goods than it
produces most efficiently and to buy the goods that it produces less
efficiently from other countries.
- Potential world production is greater with unrestricted free trade than it is
with restricted trade.
Extensions of the Ricardian model
Immobile resources resources do not always shift quite so easily from producing
one good to another. The process creates friction and human suffering. Political
opposition to the adoption of a free trade regime typically comes from those whose
jobs are most at risk.
Diminishing returns constant returns to specialization mean the units of
resources required to produce a good are assumed to remain constant no matter
where one is on a country’s production possibility frontier (PPF). Firstly, no all
resources are of the same quality. Secondly, different goods use resources in
different proportions.
Dynamic effects and Economic growth firstly, free trade increases a country’s
stock of resources as increased supplies of labor and capital from abroad. Secondly,
free trade might also increase the efficiency with which a country uses its resources.
Dynamic gains in both the stock of a country’s resources and the efficiency with
which resources are utilized cause PPF to shift outward.
The Samuelson Critique rapidly improves a country’s productivity after the
introduction of a free trade regime.
Evidence for the link between Trade and Growth adopt an open economy and
embrace free trade, your nation will be rewarded with higher eco growth rates.
Hecksher-Ohlin Theory comparative advantage arise from differences in
national factor endowments (the extent to which a country is endowed with
resources such as land, labor, and capital). It predicts that countries will export
goods that make intensive use of factors that locally abundant.
The Leontief paradox postulated that since the US was relatively abundant in the
capital compared to other nations, US would be an exporter of capital-intensive
goods and an importer of labor-intensive than US imports.
The PLC theory accurate explanation for international trade pattern.
New Trade theory
Increasing product variety and reducing costs
- opportunity for mutual gains
- Economies of scale are unit cost reductions associated with a large scale of
Eco of scale, first-mover advantages, and the pattern of trade
- First mover advantage is the eco and strategic advantages that accrue to
early entrants into an industry.
- The pattern of trade that we observe for such products my reflect first mover
Implications of New Trade theory
- nations may benefit from trade even when they do not differ in resource
endowments or technology.
- A country may predominate in the export of a good simply because it was
luck enough to have one or more firms among the first to produce that good.
- A country will predominate in the export of a product when it is particularly
well endowed with those factors used intensively in its manufacture.
- Quite useful in explaining trade patterns.
- The argument that it generates for government intervention and strategic
trade policy. It stresses the role of luck, entrepreneurship, and innovation in
giving a firm first mover advantage.
Porter’s Diamond
- factor endowments: factors of production
+ hierarchies among factors
+ relationship between advanced and basic factors (initial advantage) is
- demand conditions: home demand
- relating and supporting industries: supplier industries
- firm strategy, structure, and rivalry: governing conditions