Chapter 2

International Trade and Foreign

Direct investment
2.1 International Trade Theory

 Trade – is the concept of exchanging goods and services between two people or entities
The Classical theories are divided into 3 theories
1. Theory of Mercantilism – it holds that countries should encourage export and discourage
import.
2. Theory of absolute advantage – stated that a country should specialize in those products,
which it can produce efficiently.
3. Theory of comparative –states that trade can be beneficial for 2 countries if one country
has absolute advantage in all the products and the other country has no absolute advantage
in any of the products.
Heckscher –Ohlin Theory (Factor Proportions Theory)

 This theory is based on a country’s production factors –land, labor ,

capital, which provide the funds for investment in plants and
equipment. Factors that were in great supply relative to demand would
be cheaper; factors in great demand relative to supply would be more
expensive.
1. What is international trade?
2. Summarize the different classical trade theories, what are the difference between these
theories and how these theories evolve? Give examples
2.2 Political and Legal factors that impact
international trade
 Political System – it is basically the system of politics and government in a country. It
governs a complete set of rules, regulations, institutions and attitudes.
 Anarchism- contends that individuals should control political activities and public
government is both unnecessary and unwanted. At the other extreme is totalitarianism,
which contends that every aspect of an individual’s life should be controlled and dictated
by strong central government. In reality, neither extreme exists in its purest form.
Pluralism, asserts that both public and private groups are important in a well-functioning
political system.
 Authoritarian Governments centralize all control in the hands of one strong leader or a
small group of leaders, who have full authority.
 Democracy – is the most common form of government around the world today.
Democratic governments derive their power from the people of the country, either by
direct referendum (called a direct democracy) or by means of elected representatives of the
people (representative democracy)
 Capitalism- is an economic system in which the means of production are owned and
controlled privately.
 3 main kind of legal system
1. Civil law-based on detailed set of law
2. Common law-based on traditions and precedence
3. Religious law-based on religious guidelines
How do Governments Intervene Trade

 Tariffs –are taxes imposed on imports

 Subsidies
 Import Quotas and VER
 Currency controls
 Local content requirements
 Antidumping rules
 Export financing
 Free trade zone
 Administrative policies
Assessement 2

 1. Discuss different types of ideologies

 2.Discuss the different legal systems. Identify what system is practiced in our country
 3. Name and describe 3 policy areas in which governments can create rules and regulations
in order to control, manage and intervene in trade.
2.3 Foreign Direct Investment

2 Main categories of international investment

1. Portfolio investment –refers to the investment in a company’s stocks , bonds or assets but not for the
purpose of controlling or directing a firms operations or management
2. Foreign direct investment – refers to an investment in or the acquisition of foreign assets with the
intent to control or manage them.
Factors that influence a company's decision to invest
3. Cost
4. Logistics
5. Market
6. Natural resources
7. Customers and competitors
7. Policy
8. Culture
9. Impact
10. Expatriation of funds
11. Exit

Assessment 3.
1. Define FDI and why do governments want to control and regulate it
2. Discuss the factors that influence a companys decision to invest.