Trade Theory

Question 1

International trade definition and benefits

Answer 1

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

Question 2

Mercantilism

Answer 2

Theory that nations should accumulate financial wealth, usually in the form of gold, by encouraging exports and discouraging imports

Maintain trade surplus
Government ban imports of products
Colonialism

Question 3

Flaws of Mercantilism

Answer 3

Zero sum game - countries only benefit at the expense of others
Reduced market potential
Constrains output and consumption

Question 4

Absolute Advantage

Answer 4

Ability of a nation to produce a good more efficiently than any other

Question 5

Comparative Advantage

Answer 5

Comparative advantage is an economic term that refers to an economy’s ability to produce goods and services at a lower opportunity cost than that of trade partners

Question 6

Assumptions and limitations of comparative advantage and absolute advangtage

Answer 6

Nations strive only to maximise production and consumption
Only two countries produce and consume just two goods. Reality is many countries, many goods
No transportation costs of traded goods
Labour is the only resource used to produce goods and it cannot cross borders – no longer true
Relevance of exchange rates?
Specialisation does not create efficiency and improvement gains. Reality is it can both diminish or increase returns

Question 7

Factor Proportions Theory

Answer 7

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

Question 8

International Product Life Cycle

Answer 8

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

In Stage 1, the new product stage, the high purchasing power and demand of buyers in an industrialized country drive a company to design and introduce a new product concept. Because the exact level of demand in the domestic market is highly uncertain at this point, the company keeps its production volume low and based in the home country.
In Stage 2, the maturing product stage, the domestic market and markets abroad become fully aware of the existence of the product and its benefits. Demand rises and is sustained over a fairly lengthy period of time. As exports begin to account for an increasingly greater share of total product sales, the innovating company introduces production facilities in the countries with the highest demand. Near the end of the maturity stage, the product begins generating sales in developing nations, and perhaps some manufacturing presence is established there.
In Stage 3, the standardized product stage, competition from other companies selling similar products pressures companies to lower prices in order to maintain sales levels. As the market becomes more price sensitive, the company begins searching aggressively for low-cost production bases in developing nations to supply a growing worldwide market. Furthermore, as most production now takes place outside the innovating country, demand in the innovating country is supplied with imports from developing countries and other industrialized nations. Late in this stage, domestic production might even cease altogether.

Question 9

Limitations of the product lifestyle model

Answer 9

Model developed around the United States
United States no longer the sole innovator of products in the world
Poor depiction of the trade flows of nations
Quicker product obsolescence
Comparative advantage might better explain today’s global trade patterns

Question 10

New trade theory

Answer 10

Fundamentals…
Gains from specialisation and increasing economies of scale
Barriers to entry
Role of government – National Industrial Policy

First-mover advantage…
Economic and strategic advantage
Formidable barrier to market entry for potential rivals
Country’s export and home-based firm

Question 11

Porters diamond

Answer 11

1. Firm Strategy, Structure, and Rivalry refer to the nature of domestic rivalry. The presence of strong competitors in a nation helps create and maintain national competitive advantage.
2. Factor Conditions describe the nation’s position in factors of production, such as labor, natural resources, capital, technology and know-how.
3. Demand Conditions refers to the nature of home-market demand for specific products and services. The strength and sophistication of buyer demand facilitates the development of competitive advantages in particular industries.
4. Related and Supporting Industries refers to the presence of clusters of suppliers, competitors, and complementary firms that excel in particular industries.

Question 12

Critiques of Porters model

Answer 12

Productivity at national level became confused with explanations for firm success

Misunderstandings of the factors which determine trade,
Sustained prosperity may be achieved without a nation becoming ‘innovation‐driven’,

Inward foreign direct investment does not indicate a lack of ‘competitiveness’ or low national productivity.
The model does not offer a reliable guide to policy

Porter generalised inappropriately from the American experience, while confusing competition at industry level with trade at national level.