H1. International Economics and Business
Chapter 1 Determinants of international trade
• Composition of trade how much of every type of goods is produced.
• Trade= the voluntary exchange of goods, services, assets or money between one
person or organization and another.
• International trade= trade between residents of 2 countries.
*Trade emerges when both parties think that they will gain from it.
Modern firm based theories
Mercantilism= a 16th century economic philosophy that maintains that a country’s wealth is
measured by its holding of gold and silver.
According to mercantilists they want to increase exports and decrease imports so that they
have more money/silver/gold.
• Neo mercantilists/protectionists supports mercantilism and is used mostly by
patriots who want to strengthen their country’s economy.
*Mercantilism’s basic problem is that it confuses the acquisition of treasure with the acquisition
of wealth. But it actually weakens a country because it robs individuals of the ability to trade
freely and to benefit from voluntary exchange.
Smith’s theory of absolute advantage: Each country should specialize in the production and
export of that good which it produces most efficiently, that is, with the fewest labor hours.
Ricardo’s theory of comparative advantages: Even if one country was most efficient in the
production of two products, it must be relatively more efficient in the production of one good. It
should then specialize in the production and export of that good in exchange for the importation
of the other good.
Heckscher and Ohlin’s Theory of factor proportions : A country that is relatively labor
abundant (capital abundant) should specialize in the production and export of that product in
which is relatively labor intensive(capital intensive).
Study production possibilities graph page 18-21
What benefits/restrains international trade flows?
-Government interventions (import tariffs)
-Aggregate demand approach (demand-side of the Economy)
1
,*There are a number of factors which prevent us from benefiting fully from comparative
advantage. Some arise naturally (for example transport costs) and others are artificially imposed
(customs duties).
Obstacles to trade which arise by political restrictions:
- Tariffs and Quotas
- Political frontiers
- Currencies
- Disguised Barriers( discrimination of foreign products by government)
- Trade Diversion
Naturally imposed obstacles to trade:
- Transport costs
- Factor immobility
- Increasing costs
*Another obstacle is that specialization itself can create problems if there is a change in demand
because comparative advantages can change. For example production was first in Europe but
now almost all clothes are produced in Asia.
Natural advantage: climate and natural resources.
Acquired advantage: Product technology
*According to the factor proportions theory, factors in relative abundance are cheaper than
factors in relative scarcity.
• Factor proportions theory: this theory is based on a countries production factors which
are land, entrepreneurship, labor and capital.
*The advantages and disadvantages countries have when exporting or making products may
have come because of one of their factor proportions. In countries where there are many people
relative to land houses and land is more expensive than in countries where there is a lot of land
and in countries where labor costs are cheaper than others companies want to produce their
products there.
2
,*Companies may substitute capital for labor depending on the cost of each.
*Manufacturing is a sector that depends on acquired advantage, largely technology, which
depends in turn on large number of highly educated people and a large amount of capital to
incest in research and development.
*Since World War 2, international business research has focused on the role of the firm rather
than the country in promoting international trade. Firm-based theories have developed for
several reasons:
1. Growing importance of Multinational Companies in the postwar international economy
2. The inability of the country-based theories to explain and predict the existence and
growth of intraindustry trade
3. The failure of Leontief and other researchers to empirically validate the country-based
Heckscher-Ohlin theory
• Inter industry trade= the exchange of goods produced by one industry in country A for
goods produced by a different industry in country B, such as exchange in French wines
for Japanese clock radios.
• Intra industry trade= trade between 2 countries of goods produced by the same
industry. (accounts for more than 40 percent of world trade)
Linder’s country similarity theory: This theory suggests that most trade in manufactured
goods should be between countries with similar per capita incomes and that intra industry trade
in manufactured goods should e common.
International Product life cycle theory: traces the roles of innovation, market expansion,
comparative advantage and strategic responses of global rivals in international production,
trade, and investment decisions.
*Firms competing in the global market place have numerous ways of obtaining a sustainable
competitive advantage. The most popular ones are:
- Owning intellectual property rights
- Investing in research and development
- Achieving economies of scale or scope
- Exploiting the experience curve.
3
, Porter’s theory of national competitive advantages: this states that success in international
trade comes from the interaction of four country- and firm-specific elements: factor conditions,
demand conditions, related and supporting industries, and firm strategy, structure and rivalry.
• Tax incidence= the division of the burden of a tax between the buyer and the seller.
*When demand is perfectly inelastic, buyer pays full amount of tax and when the demand is
perfectly elastic the seller pays the full amount.
*When supply is perfectly inelastic, seller pays full amount of the tax and when the supply is
perfectly elastic the buyer pays the full amount.
study and understand graphs p. 30-3
• Protectionism = the restriction of international trade. There are 2 main protectionist
methods employed by government:
- Tariffs a tax that is imposed by the importing country when an imported good crosses
its international boundary
- Non-tariff barriers any action other than a tariff that restricts international trade for
example quantitative restrictions and licensing regulations.
• General agreement on tariffs and trade (GATT)= an international agreement designed
to limit government intervention to restrict international trade. It was negotiated and in
1947. The goal of this agreement is to liberalize trading activity and to provide an
organization to administer more liberal trading arrangements.
• World trade organization(WTO)Membership of the WTO imposes greater obligation
on countries to observe the GATT rules and makes subsidies much harder to use as an
alternative to tariffs and other forms of protection
• Common agricultural policy(CAP)Is a price support programme for farmers in the
European Union and acts as a tariff on non EU agricultural products . Prices of countries
are therefore a lot more expensive than those in the EU countries.
Study page 36-41 the graphs of free-trade, tariff and quotas
• Tariff=tax on goods that are getting imported. It is the oldest form of trade policy and
have traditionally been used as a source of government income.
• Specific tariffsfixed charge for each for each unit of good imported(3 dollars on every
barrel of wheat)
• Ad valorem tariffs are taxes that are levied as a fraction of the value of the imported
goods(25% of all the imported trucks)
*The importance of tariffs has declined in modern times, because modern governments usually
prefer to protect domestic industries through a variety of non-tariff barriers (import quotas-
limitations on the quantity of imports) and (export restraints- limitations on the quantity of
exports)
4
Chapter 1 Determinants of international trade
• Composition of trade how much of every type of goods is produced.
• Trade= the voluntary exchange of goods, services, assets or money between one
person or organization and another.
• International trade= trade between residents of 2 countries.
*Trade emerges when both parties think that they will gain from it.
Modern firm based theories
Mercantilism= a 16th century economic philosophy that maintains that a country’s wealth is
measured by its holding of gold and silver.
According to mercantilists they want to increase exports and decrease imports so that they
have more money/silver/gold.
• Neo mercantilists/protectionists supports mercantilism and is used mostly by
patriots who want to strengthen their country’s economy.
*Mercantilism’s basic problem is that it confuses the acquisition of treasure with the acquisition
of wealth. But it actually weakens a country because it robs individuals of the ability to trade
freely and to benefit from voluntary exchange.
Smith’s theory of absolute advantage: Each country should specialize in the production and
export of that good which it produces most efficiently, that is, with the fewest labor hours.
Ricardo’s theory of comparative advantages: Even if one country was most efficient in the
production of two products, it must be relatively more efficient in the production of one good. It
should then specialize in the production and export of that good in exchange for the importation
of the other good.
Heckscher and Ohlin’s Theory of factor proportions : A country that is relatively labor
abundant (capital abundant) should specialize in the production and export of that product in
which is relatively labor intensive(capital intensive).
Study production possibilities graph page 18-21
What benefits/restrains international trade flows?
-Government interventions (import tariffs)
-Aggregate demand approach (demand-side of the Economy)
1
,*There are a number of factors which prevent us from benefiting fully from comparative
advantage. Some arise naturally (for example transport costs) and others are artificially imposed
(customs duties).
Obstacles to trade which arise by political restrictions:
- Tariffs and Quotas
- Political frontiers
- Currencies
- Disguised Barriers( discrimination of foreign products by government)
- Trade Diversion
Naturally imposed obstacles to trade:
- Transport costs
- Factor immobility
- Increasing costs
*Another obstacle is that specialization itself can create problems if there is a change in demand
because comparative advantages can change. For example production was first in Europe but
now almost all clothes are produced in Asia.
Natural advantage: climate and natural resources.
Acquired advantage: Product technology
*According to the factor proportions theory, factors in relative abundance are cheaper than
factors in relative scarcity.
• Factor proportions theory: this theory is based on a countries production factors which
are land, entrepreneurship, labor and capital.
*The advantages and disadvantages countries have when exporting or making products may
have come because of one of their factor proportions. In countries where there are many people
relative to land houses and land is more expensive than in countries where there is a lot of land
and in countries where labor costs are cheaper than others companies want to produce their
products there.
2
,*Companies may substitute capital for labor depending on the cost of each.
*Manufacturing is a sector that depends on acquired advantage, largely technology, which
depends in turn on large number of highly educated people and a large amount of capital to
incest in research and development.
*Since World War 2, international business research has focused on the role of the firm rather
than the country in promoting international trade. Firm-based theories have developed for
several reasons:
1. Growing importance of Multinational Companies in the postwar international economy
2. The inability of the country-based theories to explain and predict the existence and
growth of intraindustry trade
3. The failure of Leontief and other researchers to empirically validate the country-based
Heckscher-Ohlin theory
• Inter industry trade= the exchange of goods produced by one industry in country A for
goods produced by a different industry in country B, such as exchange in French wines
for Japanese clock radios.
• Intra industry trade= trade between 2 countries of goods produced by the same
industry. (accounts for more than 40 percent of world trade)
Linder’s country similarity theory: This theory suggests that most trade in manufactured
goods should be between countries with similar per capita incomes and that intra industry trade
in manufactured goods should e common.
International Product life cycle theory: traces the roles of innovation, market expansion,
comparative advantage and strategic responses of global rivals in international production,
trade, and investment decisions.
*Firms competing in the global market place have numerous ways of obtaining a sustainable
competitive advantage. The most popular ones are:
- Owning intellectual property rights
- Investing in research and development
- Achieving economies of scale or scope
- Exploiting the experience curve.
3
, Porter’s theory of national competitive advantages: this states that success in international
trade comes from the interaction of four country- and firm-specific elements: factor conditions,
demand conditions, related and supporting industries, and firm strategy, structure and rivalry.
• Tax incidence= the division of the burden of a tax between the buyer and the seller.
*When demand is perfectly inelastic, buyer pays full amount of tax and when the demand is
perfectly elastic the seller pays the full amount.
*When supply is perfectly inelastic, seller pays full amount of the tax and when the supply is
perfectly elastic the buyer pays the full amount.
study and understand graphs p. 30-3
• Protectionism = the restriction of international trade. There are 2 main protectionist
methods employed by government:
- Tariffs a tax that is imposed by the importing country when an imported good crosses
its international boundary
- Non-tariff barriers any action other than a tariff that restricts international trade for
example quantitative restrictions and licensing regulations.
• General agreement on tariffs and trade (GATT)= an international agreement designed
to limit government intervention to restrict international trade. It was negotiated and in
1947. The goal of this agreement is to liberalize trading activity and to provide an
organization to administer more liberal trading arrangements.
• World trade organization(WTO)Membership of the WTO imposes greater obligation
on countries to observe the GATT rules and makes subsidies much harder to use as an
alternative to tariffs and other forms of protection
• Common agricultural policy(CAP)Is a price support programme for farmers in the
European Union and acts as a tariff on non EU agricultural products . Prices of countries
are therefore a lot more expensive than those in the EU countries.
Study page 36-41 the graphs of free-trade, tariff and quotas
• Tariff=tax on goods that are getting imported. It is the oldest form of trade policy and
have traditionally been used as a source of government income.
• Specific tariffsfixed charge for each for each unit of good imported(3 dollars on every
barrel of wheat)
• Ad valorem tariffs are taxes that are levied as a fraction of the value of the imported
goods(25% of all the imported trucks)
*The importance of tariffs has declined in modern times, because modern governments usually
prefer to protect domestic industries through a variety of non-tariff barriers (import quotas-
limitations on the quantity of imports) and (export restraints- limitations on the quantity of
exports)
4
