International Trade Theory: Eighth Edition

International Business: The Challenges
of Globalization
Eighth Edition
Chapter 5
International
Trade Theory
Copyright © 2016, 2014, 2012 Pearson Education, Inc. All Rights Reserved.
Learning Objectives
5.1 Describe the benefits, volume, and patterns of international
trade.
5.2 Explain how mercantilism worked and identify its inherent
flaws.
5.3 Detail the theories of absolute advantage and comparative
advantage.
5.4 Summarize the factor proportions theory of trade.
5.5 Explain the international product life cycle theory.
5.6 Outline the new trade theory and the first-mover advantage.
5.7 Describe the national competitive advantage theory and the
Porter diamond.
From Bentonville to Beijing
• In 1991 Walmart first became an
international company.
• Ambitious global expansion:
– Walmart has around 5,000 stores in
the United States and more than
6,000 stores in 26 other countries.
– Nearly $466 billion in sales globally.
– Walmart is one of the world’s largest
companies.
– Walmart sources inexpensive
merchandise from low-cost
production locations such as China.
• Helping boost international trade.
Benefits, Volume, and Patterns
of International Trade (1 of 4)
Benefits of International Trade
• International Trade: Purchase, sale, or exchange of goods
and services across national borders
• Benefits of International Trade:
– Greater choice of goods and services
– Important engine for job creation in many countries
Volume of International Trade
Table 5.1 World’s Top Exporters
World’s Top Merchandise Exporters World’s Top Service Exporters
Share of Value Share of World
Value World Rank Exporter (U.S. $ billions) Total (%)
Rank Exporter (U.S. $ billions) Total (%)
1 United States 621 14.3
1 China 2,049 11.1
2 United Kingdom 280 6.4
2 United States 1,546 8.4
3 Germany 257 5.9
3 Germany 1,407 7.6
4 France 211 4.8
4 Japan 799 4.3
5 China 190 4.4
5 Netherlands 656 3.6
6 Japan 142 3.3
6 France 569 3.1
7 India 141 3.2
7 South Korea 548 3.0
8 Spain 136 3.1
8 Russia Fed. 529 2.9
9 Netherlands 131 3.0
9 Italy 501 2.7
10 Hong Kong 123 2.8
10 Hong Kong 493 2.7
Source: Based on International Trade Statistics 2013 (Geneva: World Trade Organization, November 2013),
Tables I.7 and I.9, available at www.wto.org.
International Trade Patterns
Table 5.2 Regional Merchandise Trade (Percentage)
Destination Blank Blank Blank Blank Blank Blank Blank Blank
North South and Commonwealth of Middle

Origin World America Central America Europe Independent States Africa East Asia
North America 13.2 37.9 27.6 5.8 3.3 6.5 10.5 9.2
South and Central
America 4.2 6.2 25.6 1.9 1.5 3.6 2.4 3.2
Europe 35.6 16.2 15.7 66.8 44.6 36.3 29.2 12.0
Commonwealth of
Independent States 4.5 1.2 0.9 6.6 27.0 2.4 2.8 2.4
Africa 3.5 2.4 3.9 3.7 0.3 13.9 2.4 3.0
Middle East 7.5 3.9 1.4 2.3 1.3 6.8 16.2 13.7
Asia 31.5 32.1 24.9 13.0 21.9 30.4 36.5 56.5
Note: Columns do not equal 100.0 due to mathematical rounding and national differences in data recording
methods.
Source: Based on International Trade Statistics 2013 (Geneva: World Trade Organization, November 2013),
Tables I.7 and I.9, available at www.wto.org.
Trade Interdependence
• Trade among most nations is characterized by a degree
of interdependency.
• Trade dependency has been a blessing for many Central
and Eastern European nations.
• The dangers of trade dependency become apparent
when a nation experiences economic recession or
political turmoil.
Quick Study 1
1. List several benefits of international trade.
2. World merchandise exports are valued at how many
times the value of worldwide service exports?
3. What portion of total world merchandise trade is
accounted for by two-way trade between high-income
economies?
4. What term often describes the nature of trade between
a developing nation and a neighboring wealthy one?
Mercantilism (1 of 3)
Figure 5.1 Trade Theory Timeline
How Mercantilism Worked
• Mercantilism: Trade theory that nations should accumulate
financial wealth, usually in the form of gold, by encouraging
exports and discouraging imports
Three Pillars
• Maintain Trade Surplus
• Government Intervention
• Colonialism
Flaws of Mercantilism
Flaws
• World trade is a zero-sum game
• Limits colonies’ market potential
• Constrains output and consumption
Quick Study 2
1. What did the successful implementation of mercantilism
require?
2. Mercantilist nations acquired colonies around the world to
serve as sources of what?
3. What name is given to the belief that a nation can
increase its wealth only at the expense of other nations?
Theories of Absolute and Comparative
Advantage (1 of 5)
Absolute Advantage
• Absolute Advantage: Ability of a nation to produce a good
more efficiently than any other nation
Blank Units Required for Production Units Required for Production
Rice Tea
Riceland 1 5
Tealand 6 3
Another way of stating each nation’s efficiency in the production

of rice and tea is:
1
• In Riceland, 1 unit of resources = 1 ton of rice or ton of tea
5
• In Tealand, 1 unit of resources = 1 ton of rice or 1 ton of tea
6 3
Advantage (2 of 5)
Specialization and trade: Figure 5.2 Gains from Specialization
and Trade: Absolute Advantage
+ Riceland gets five times
more tea than it would
have produced itself.
+ Tealand gets two times
more rice than it would
Advantage (3 of 5)
Comparative Advantage
• Comparative Advantage: Inability of a nation to produce a
good more efficiently than other nations but an ability to produce
that good more efficiently than it does any other good
Blank Units Required for Production Units Required for Production
Rice Tea
Riceland 1 2
Tealand 6 3
Another way of stating each nation’s efficiency in the production

of rice and tea is:
1
• In Riceland, 1 unit of resources = 1 ton of rice or ton of tea
2
• In Tealand, 1 unit of resources = 1 ton of rice or 1 ton of tea
6 3
Advantage (4 of 5)
Specialization and trade: Figure 5.3 Gains from Specialization
and Trade: Comparative Advantage
+ Riceland gets two times
more tea than it would
+ Tealand gets two times
more rice than it would
Advantage (5 of 5)
Assumptions and Limitations
• Nations strive only to maximize production and
consumption.
• Only two countries produce and consume just two goods.
• No transportation costs of traded goods.
• Labor is the only resource used to produce goods and it
cannot cross borders.
• Specialization does not create efficiency and improvement
gains.
Quick Study 3
• A nation that is able to produce a good more efficiently
than other nations is said to have what?
• What does a nation have when it is unable to produce a
good more efficiently than other nations but it can produce
the good more efficiently than it can any other good?
• The theories of absolute advantage and comparative
advantage say that nations benefit from trading because
of the gains from what?
Factor Proportions Theory (1 of 2)
• Factor Proportions Theory: Trade theory stating that
countries produce and export goods that require resources
(factors) that are abundant and import goods that require
resources in short supply
Factor Proportions Theory (2 of 2)
The Leontief Paradox
• The Apparent Paradox
– Leontief found evidence opposite of that predicted by the factor
proportions theory.
 U.S. exports require more labor-intensive than U.S. imports.
 Leontief’s findings are supported by more-recent research.
– Paradox between the predictions using the factor proportions
theory and the actual trade flows.
• What might account for the paradox?
– Factor proportions theory assumes nation’s production factors
to be homogeneous.
– Factor proportions theory seems to be supported when
expenditures on labor are taken into account.
Quick Study 4
1. What is the name of the theory that says countries
produce and export goods that require resources that
are abundant and import goods that require resources
in short supply?
2. Factor proportions theory divides a nation’s resources
into what two categories?
International Product Life Cycle (1 of 2)
Stages of the Product Life Cycle
• International Product Life Cycle: Theory stating that a company
will begin by exporting its product and later undertake foreign
direct investment as the product moves through its life cycle
Figure 5.4 International Product Life Cycle
International Product Life Cycle (2 of 2)
• Vernon developed his model around the United States.
• The United States is no longer the sole innovator of
products in the world.
• The theory’s ability to accurately depict the trade flows
of nations is weak.
• Today, there is quicker product obsolescence.
• Older theories might better explain today’s global trade
patterns.
Quick Study 5
1. The international product life cycle theory says that a
company will begin by exporting its product and later
undertake what as the product moves through its life
cycle?
2. List the three stages that a product goes through
according to the international product life cycle theory.
3. Whenever optimizing productivity determines where a
product’s components are manufactured and where it is
assembled, the resulting pattern of activities resembles
that predicted by which theory?
New Trade Theory
Fundamentals First-Mover Advantage
• Gains from specialization • Economic and strategic
and increasing economies advantage
of scale
• Formidable barrier to market
• Barriers to entry entry for potential rivals
• Role of government • Country’s export and home-
based firm
Quick Study 6
1. What is the main thrust of the new trade theory?
2. The economic and strategic advantage gained by being
the first company to enter an industry is called what?
National Competitive Advantage
1. Factor Conditions
• Basic Factors
• Advanced Factors
2. Demand Conditions
• Sophisticated Buyers
3. Related and Supporting Industries

• Clusters
4. Firm Strategy, Structure, and Rivalry

• Competitiveness
Government and Chance

• Role of Government
• Chance Events
Quick Study 7
1. The national competitive advantage theory states that a
nation’s competitiveness in an industry depends on the
capacity of the industry to do what?
2. The four main components of the Porter diamond are: (1)
factor conditions, (2) demand conditions, (3) firm strategy,
structure, and rivalry, and what else?
3. A group of related industries that spring up in a geographic
area to support a nation’s competitiveness.
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International Business: The Challenges

North South and Commonwealth of Middle

Another way of stating each nation’s efficiency in the production

Another way of stating each nation’s efficiency in the production

3. Related and Supporting Industries

4. Firm Strategy, Structure, and Rivalry

Government and Chance

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