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Theories of International Trade
Factors that drive trade and their consequences for MNEs
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Session 03
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The Ricardian Model
Specialisation on the basis of opportunity (comparative) cost advantage
If, in two countries, the ratio of exchange between two commodities isdifferent international trade will emerge
Portugal England
Opportunitycost of Wine
80/90=0.89 120/100=1.2
Opportunity
cost of Cloth
90/80=1.12 100/120=0.83
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Opportunity cost of wine in Portugal is less than that in England
Opportunity cost of cloth in England is less than that in Portugal
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The Heckscher-Ohlin-Samuelson Model
Countries will export those goods whoseproduction is relatively intensive in the factorswith which they are well endowed
A country has a comparative advantage in thegoods that make relatively intensive use of thecountrys relatively abundant factor
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Implications of the theoriesof Comparative Advantage
International trade will tend to equalise factor pricesacross countries that trade Factor price equalisationTheorem.
An increase in the endowment of one of the factors willreduce the production of goods that intensively use theother factor Rybczynski Theorem.
Free trade will increase the real income of the relativelyabundant factor and reduce that of the relatively scarcefactor Stolper-Samuelson Theorem.
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Alternative Theoriesof International Business
Scale Economies (Returns to scale)
Imperfect Competition
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Scale Economies
Internal to the firm External to the firm
National Concentration ofproduction in a large,
efficient plant
A large industrysupporting an
industrial labour forceand extensiveinfrastructure
International R&D by a multi-
national firm
Extensive division of
labour in an industrywith low barriers totrade andcommunication
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Scale Economies are a Basis for Trade
Increasing returns to scale provide a basis fortrade independent of comparative advantage
A firm possessing internal economies of scalepotentially monopolises an industry, creatingimperfect market, both domestically andinternationally.
If it produces more, lowering the cost per unit, itcan lower the market price and sell moreproducts, because it sets the market price
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The industry that possesses external economies mayproduce at lower costs than the same industry that issimilar in size in other countries.
A country can dominate world markets in a particularproduct, not because it has one massive firm producingenormous quantities, but because it has many small firmsthat interact to create a large, competitive, critical mass.
No one firm need be all that large, but all small firms intotal may create such competitive industry that firms inother countries cannot break into the industry on acompetitive basis.
When increasing returns to scale are international, tradebetween countries with similar patterns of resourceallocation will tend to be intra-industry, and tradebetween countries with different patterns of resourceallocation will tend to be inter-industry.
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Alternative Theoriesof International Business
(Cont)
Product differentiation
Externalities
Irreversible investmentsStrategic trade/Managed trade
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Free Trade Vs Protection
Free Trade
A system of commercial policy which draws no distinctionbetween domestic and foreign commodities and thus neitherimposes additional burden on the latter nor grants anyspecial favour to the former
Maximisation of output: P = Px/Py= MCx/MCy= MRT
Optimisation of consumption: P = Px/Py= MUx/MUy= MRS
Wordwide Pareto Optimality: MRS = MRT
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Forms of Protection
Tariff Barriers Ad valorem duty
Specific duty
Compound duty
Non-tariff Barriers (NTBs)
Quota, VERs
Export subsidy/tax
Import deposits/licensing
State trading monopolies
Exchange controls
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Impact of Protection onNational Welfare
Decline in the volume of trade
Protects domestic prices
Rise in domestic production Domestic consumption declines
Increase in govt. revenue
National welfare falls
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Why State Intervention?
Infant industry argument
Domestic distortions in commoditymarkets
Distortions in factor markets
Revenue
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Readings
Chapter 6, A K Sundaram and J S Black.
Exercise on comparative cost advantage.
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