Urgent 5 questions- answers needed

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Chapter 5, Trading Internationally

Trading Internationally

Learning Outcomes

Use the resource-based and institution-based views to explain why nations trade

Identify and define the classical and modern theories of international trade

Explain the importance of political realities governing international trade

Identify factors that should be considered when your firm participates in international trade

LEARNING OUTCOMES

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Important Terms Related to Trade

International trade - Exports and imports

Consists of:

Merchandise (goods) trade: Tangible products being bought and sold

Service trade: Intangible services being bought and sold

LO 1

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Exporting: Selling products abroad

Importing: Buying from abroad

Important Terms Related to Trade (continued)

Balance of trade: Country-level trade surplus or deficit

Trade deficit: Occurs when a nation imports more than it exports

Trade surplus: Occurs when a nation exports more than it imports

LO 1

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Need for International Trade

Resource-based view

Firms in one nation generate exports that are valuable, unique, and hard to imitate

Beneficial for foreign firms to import

Institution-based view

Different rules governing trade are designed to determine how gains are shared or not shared

Both sides must have economic gains

LO 1

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Theories of International Trade - Mercantilism

Holds that wealth of the world is fixed

Nation that exports more than it imports will enjoy the net inflows of gold and silver and become richer

Intellectual ancestor of modern-day protectionism

Protectionism: Idea that governments should actively protect domestic industries from imports and promote exports

LO 2

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Theories of International Trade - Absolute Advantage

Advocated by Adam Smith

Under free trade, each nation gains by specializing in economic activities in which it is the most efficient producer

Free trade: Free market forces should determine the buying and selling of goods and services

There is little or no government intervention

LO 2

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International trade is a win-win game. Specializing in the production of goods for which each party has an absolute advantage enables both to produce more, and both the parties can benefit more by trading.

5.3 - Absolute Advantage

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Exhibit

This view suggests that international trade is not a zero-sum game but a win-win game. This is because a nation can focus on an activity that it can perform efficiently while importing goods that it needs from another nation that can perform that activity more efficiently.

5.4 - Absolute Advantage

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Exhibit

Between the production of wheat and making aircraft, the United States has an absolute advantage in making aircraft (20 resources versus 40 resources), while China has an absolute advantage in the production of wheat (20 resources versus 80 resources). Both nations need wheat and aircraft, but without trading with each other, both nations would have to spend half their resources in producing both goods. By trading with each other, both nations produce more and save more. Thus, there is a net gain from trade.

Theories of International Trade - Comparative Advantage

A nation gains by specializing in production of one good in which it has comparative advantage

Comparative advantage: Relative advantage in one economic activity that one nation enjoys in comparison with other nations

Developed by David Ricardo

LO 2

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Theories of International Trade - Comparative Advantage (continued 1)

Net gains are availed through trade

Opportunity cost: Cost of pursuing one activity at the expense of another activity

Counterintuitive

Realistic and useful during application

Absolute and comparative advantages arise from:

Productivity

Absolute advantage deals with productivity differences

LO 2

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Theories of International Trade - Comparative Advantage (continued 2)

Comparative advantage emphasizes relative productivity differences

Factor endowment: Extent to which different countries possess various factors of production (labor, land, and technology)

Factor endowment theory: Nations will develop comparative advantages based on locally abundant factors

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Swedish economists Eli Heckscher and Bertil Ohlin argued that absolute and comparative advantages stem from different factor endowments. Factor endowment theory is also known as the Heckscher–Ohlin theory.

5.5 - Comparative Advantage

LO 2

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Exhibit

5.6 - Comparative Advantage

LO 2

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Exhibit

This theory suggests that even though the United States has an absolute advantage in the production of both wheat and aircraft over China, as long as China is not equally less efficient in the production of both goods, China can still specialize in the production of one good in which it has a comparative advantage. In this example, China is relatively less inefficient than the United States in producing wheat. If China devotes all resources to wheat, it can produce 10,000 tons, which is four-fifths of the 12,500 tons that the United States

can produce. However, at a maximum, China can produce only 20 aircraft, which is merely half of the 40 aircraft that the United States can make. By letting China specialize in the production of wheat and importing some wheat from China, the United States is able to leverage its strengths by devoting its resources to aircraft. The net gains are caused by comparative advantage.

Theories of International Trade - Product Life Cycle

Patterns of trade change over time as production shifts and product moves from new to maturing to standardized stages

Developed by Raymond Vernon

Dynamic theory

Divided the world into three categories

Lead innovation nation, developed nations, and developing nations

LO 2

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Mercantilism, absolute advantage, and comparative advantage paint a static picture. The product life cycle theory is a dynamic theory. Every product has three life cycle stages.

Stage one - Production of a new product that commands a price premium, with production focused in the United States

Stage two - Maturing stage, in which the demand and ability to produce grow in other developed countries

Stage three - New product is standardized, and production moves to low-cost developing countries.

Theories of International Trade - Product Life Cycle (continued)

Criticism of product life cycle theory

Assumes:

United States’ permanent position as lead innovation nation for new products

Stage-by-stage migration of production that takes a longer duration

LO 2

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This theory assumes that the United States will always be the lead innovation nation, a view that may be becoming increasingly invalid.

The theory also assumes a stage-by-stage migration of production.

Theories of International Trade - Strategic Trade

Strategic government intervention in certain industries enhance their odds for international success

Strategic trade policy: Provides companies a strategic advantage through government subsidies

LO 2

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The type of industries that benefit from government intervention tend to be highly capital-intensive industries with high barriers to entry, where domestic firms may have little chance of entering and competing without government assistance. These industries also feature substantial first-mover advantages, advantages that first entrants enjoy and do not share with late entrants.

Theories of International Trade - Strategic Trade (continued)

Criticism

Scholars and policy makers are uncomfortable with government intervention

Industries claim they are strategically important

LO 2

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5.8 - Entering the Very Large, Super-Jumbo Market?

LO 2

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Exhibit

In this example, both Airbus and Boeing are interested in entering the super-jumbo airplane market. The demand in the next twenty years is about 400 to 500 aircraft, while each firm needs to sell 300 to be profitable, meaning that only one firm can be supported profitably. If both firms enter the market (A), both will lose $5 billion, while if only one enters (cell 2 and 3), it will make $20 billion. With government intervention of $10 billion (B), Airbus will find the market profitable no matter what Boeing does.

5.8 - Entering the Very Large, Super-Jumbo Market? (continued)

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Exhibit

The picture changes to Panel B if a number of European governments promise Airbus a subsidiary of $10 billion to enter the super-jumbo market. Regardless of what Boeing does, Airbus finds it lucrative to enter. In Cell 1, if Boeing enters, it will lose $5 billion as before, whereas Airbus will make $5 billion ($10 billion subsidy minus $5 billion loss). So Boeing has no incentive to enter. Therefore, the more likely outcome is Cell 2, where Airbus enters and enjoys a profit of $30 billion. Therefore, the subsidy has given Airbus a strategic advantage.

Theories of International Trade - National Competitive Advantage of Industries

Competitive advantage of certain industries in different nations depends on four aspects

Form a diamond shape when diagrammed

Proposed by Michael Porter

Also known as diamond theory

LO 2

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The four aspects that explain why certain industries are competitive internationally are as follows:

Factor endowment - Natural and human resources

Tough domestic demand propels firms to scale new heights.

Domestic firm strategy, structure, and rivalry in one industry play a huge role in its international success or failure.

Related and supporting industries provide the foundation upon which key industries can excel.

5.9 - National Competitive Advantage of Industries: The Porter Diamond

LO 2

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Exhibit

Evaluation of Classical Theories of International Trade

Considered as revolutionary theories when the world was dominated by mercantilistic thinking

Rely on simplistic assumptions of a model consisting of only two nations and two goods

Assume perfect resource mobility

Assume that there are no foreign exchange issues and zero transportation costs

LO 2

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Resource mobility: Assumption that a resource used in producing a product in one industry can be shifted and used in another industry

Realities of International Trade - Tariff Barriers

Discourage imports by placing a tariff or tax on imported goods

Import tariff: Tax imposed on imports

Deadweight costs: Net losses that occur in an economy as the result of tariffs

LO 3

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Realities of International Trade - Nontariff Barriers

Subsidy

Import quota

Voluntary export restraint (VER)

Local content requirement

Administrative policy

Antidumping duty

LO 3

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With growing criticism of tariff barriers, many nations are now turning to nontariff barriers to engage in trade wars.

Subsidies: Government payments to domestic firms

Import quotas: Restrictions on the quantity of goods that can be brought into a country

Quotas are the most straightforward denial of absolute or comparative advantage.

Voluntary export restraints (VERs): International agreement to show that an exporting country voluntarily agrees to restrict its exports

A response to import quotas to show that exporting countries voluntarily agree to restrict their exports

Local content requirements: Rules stipulating that a certain proportion of the value of the goods made in one country must originate from that country

Administrative policies: Bureaucratic rules that make it harder to import foreign goods

Antidumping duties: Costs levied on imports that have been “dumped,” or sold below cost to unfairly drive domestic firms out of business

Economic Arguments against Free Trade

To protect domestic industries

To shield infant industries

LO 3

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Political Arguments against Free Trade

National security

Consumer protection

Trade intervention

Environmental and social responsibility

LO 3

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Trade embargoes are politically motivated trade sanctions against foreign countries to signal displeasure.

Factors That Determine the Success and Failure of Firms’ Exports

Resource-based view

Successful exports are valuable, unique, and hard-to-imitate products

Institution-based view

Laws and regulations promoted by special interest groups can:

Protect certain domestic industries, firms, and individuals

Erect trade boundaries

Make the nation as a whole worse off

LO 4

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5.12 - Implications for Action

LO 4

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Exhibit

Key Terms

Export

Import

Merchandise (goods) trade

Service trade

Trade deficit

Trade surplus

Balance of trade

Mercantilism

Protectionism

Free trade

Theory of absolute advantage

Absolute advantage

Theory of comparative advantage

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KEY TERMS

Key Terms (continued 1)

Comparative advantage

Opportunity cost

Factor endowment

Factor endowment theory (Heckscher–Ohlin theory)

Product life cycle theory

Strategic trade theory

First-mover advantage

Strategic trade policy

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KEY TERMS (continued)

Key Terms (continued 2)

Theory of national competitive advantage of industries (diamond theory)

Resource mobility

Tariff barrier

Import tariff

Deadweight cost

Nontariff barrier (NTB)

Subsidy

Import quota

Voluntary export restraint (VER)

Local content requirement

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KEY TERMS (continued)

Key Terms (continued 3)

Administrative policy

Antidumping duty

Trade embargo

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KEY TERMS (continued)

Summary

International trade provides economic gains

Gains are shared by both exporters and importers

Theories of international trade are divided into classical and modern trade theories

Trade barriers include tariff and non-tariff barriers

Managers must leverage the comparative advantage of world-class locations

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SUMMARY

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