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