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This type of trade allows for a
greater competition and more competitive pricing in the market
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The exchange of goods also affects
the economy of the world as dictated by supply and demand, making goods and
services obtainable which may not otherwise be available to consumers globally
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The Benefits of Trade
Smith, Ricardo and Heckscher-Ohlin show why it is beneficial for a country to engage in
international trade even for products it is able to produce for itself
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Some patterns of trade are fairly easy to explain - it is obvious why Saudi Arabia exports oil,
the US exports agricultural products, and Mexico exports labor intensive goods
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Trade Theory and Government Policy
The various theories have differing prescriptions for government policy on trade
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Smith, Ricardo, and Heckscher-Ohlin promote unrestricted free trade
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Mercantilism
Mercantilism suggests that it is in a country’s best interest to maintain a trade surplus -- to
export more than it imports, and advocates government intervention to achieve a surplus in
the balance of trade
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• Emphasized on international trade but contribute little to economic theory
• Indirect contributions:
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Promoting nationalism
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Expanding the internal market
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The idea of a wealthy society was to have exports exceed imports (trade surplus) so
that the king’s treasure chests could be filled with money
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• Increased exports leads to inflation and higher prices
• Increased imports lead to lower prices
• Result: Country A sells because of high prices and Country B sells more because of
lower prices
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Absolute Advantage
• Adam Smith argued that countries differed in their ability to produce goods
efficiently, and should specialize in the production of the goods they can produce the
most efficiently
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If Britain were to specialize in textile production, and Spain in wine production,
Smith argued that both Britain and Spain could consume more textiles and wine than
if each only produced for their own consumption
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Comparative Advantage
David Ricardo asked what might happen when one country has an absolute advantage in the
production of all goods
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Heckscher-Olin Theory
The Heckscher-Ohlin theory predicts that countries will export those goods that make
intensive use of factors of production which are locally abundant, while importing goods that
make intensive use of factors that are locally scarce
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The Leontief Paradox
• Wassily Leontief theorized that since the U
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was relatively abundant in capital
compared to other nations, the U
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would be an exporter of capital intensive goods
and an importer of labor-intensive goods
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S
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S
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Globalization weakens this theory
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Firms with first mover advantages will develop economies of scale and create barriers
to entry for other firms
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Increasing Product Variety:
• Without trade, nations might not be able to produce those products where economies
of scale are important
• With trade, markets are large enough to support the production necessary to achieve
economies of scale
• So, trade is mutually beneficial because it allows for the specialization of production,
the realization of scale economies, and the production of a greater variety of products
at lower prices
Economies Of Scale, First Mover Advantages, And The Pattern Of Trade:
• The pattern of trade we observe in the world economy may be the result of first mover
advantages (the economic an strategic advantages that accrue to early entrants into an
industry) and economies of scale
• New trade theory suggests that for those products where economies of scale are
significant and represent a substantial proportion of world demand, first movers can
gain a scale based cost advantage that later entrants find difficult to match
Theory of National Competitive Advantage: Porter’s Diamond
Michael Porter hypothesizes that a nation’s competitiveness depends on the capacity of its
industry to innovate and upgrade
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This study found four broad attributes that
promote or impede the creation of competitive advantage: factor endowments, demand
conditions, relating and supporting industries, and firm strategy, structure, and rivalry
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Evaluating Porter’s Theory
In addition to these four main attributes, government policies and chance can impact any of
the four
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Advanced factors:
The result of investment by people, companies, and government are more likely to
lead to competitive advantage
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Relating And Supporting Industries
• Relating and supporting industries refer to the presence or absence of supplier
industries and related industries that are internationally competitive
• The presence supplier industries and related industries that are internationally
competitive can spill over and contribute to other industries
• Successful industries tend to be grouped in clusters in countries - having world class
manufacturers of semi-conductor processing equipment can lead to (and be a result of
having) a competitive semi-conductor industry
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