Chapter 06 – International Trade Theory
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International Trade Theory
Learning objectives
• Understand why nations trade
nations.
• Recognize why many economists
that participate in a free trade
system.
can play a proactive role in
promoting national competitive
advantage in certain industries.
trade theory holds for business
practice.
This chapter presents the major theories of
international trade. Scholars first began to offer
explanations for trade in the fifteenth century.
Approaches to trade range from support for free
trade to managed trade, to mercantilist
approaches, to controlled trade, and even, in
certain to hurt some domestic industries that are
not competitive globally. Workers in the U.S.
textile industry, for example, may lose jobs to
The opening case considers international trade in
the Trump era. President Trump has made no
candidate, Trump strongly criticized the
agreement and threatened to withdraw. As
President, Trump failed to see any real benefit
6
Chapter 06 – International Trade Theory
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OUTLINE OF CHAPTER 6: INTERNATIONAL TRADE THEORY
Opening Case: Donald Trump on Trade
Mercantilism
Country Focus: Is China Manipulating Its Currency in Pursuit of a Neo-
Mercantilist Policy?
Absolute Advantage
Comparative Advantage
The Leontief Paradox
The Product Life-Cycle Theory
Product Life-Cycle Theory in the Twenty-First Century
New Trade Theory
Increasing Product Variety and Reducing Costs
Related and Supporting Industries
Firm Strategy, Structure, and Rivalry
Evaluating Porter’s Theory
Focus on Managerial Implications
Location
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Critical Thinking and Discussion Questions
Closing Case: The Trans Pacific Partnership (TPP)
Appendix: International Trade and the Balance of Payments
Balance-of-Payments Accounts
Does the Current Account Deficit Matter?
CLASSROOM DISCUSSION POINT
Ask students why countries trade with each other. Write their responses on the board and
try to group the responses according to the various theories presented in the text.
Next, ask them what would happen if countries did not trade with each other. Again,
write the responses on the board using the same format.
Finally, identify how their responses fit into the country/firm framework, and then refer
back to their responses throughout the presentation of the material in the chapter.
OPENING CASE: Donald Trump on Trade
Summary
The opening case explores international trade in the Trump era. Throughout his
campaign, Donald Trump criticized nearly every trade agreement signed by the United
States including one of its most important agreements, the North American Free Trade
Agreement (NAFTA). As a candidate, Trump threatened to pull out of agreements he felt
were not beneficial to the United States unless more favorable terms were negotiated.
Now as president, Trump appears to be ready to do just that. Trump apparently views
international trade as a zero-sum game in which one country benefits at the expense of
another rather than as a positive sum gain where there can be mutual benefit. Discussion
of the case can begin with the following questions:
QUESTION 1: Discuss President Trump’s position on trade. In your opinion, is he right?
Explain your response.
ANSWER 1: This question is likely to generate considerable discussion and controversy
among students. It was a central focus of the 2016 presidential election and students will
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likely focus on Trump’s belief that trade is a zero-sum game and his apparent disregard
for the notion of mutually beneficial relationships.
QUESTION 2: For the last 70 years, the United States has been a global economic and
political leader working with countries to open borders and promote foreign investment.
Trump has promised a more isolationist, America-first administration. If America turns
inward, putting up barriers to trade, how do you think other nations will respond?
ANSWER 2: Responses to this question will differ by student. Most will probably argue
QUESTION 3: Donald Trump won the 2016 presidential election with promises to bring
back blue-collar jobs in manufacturing and coal. Reflect on job losses in these areas. Is
trade the only reason or even the main reason for these job losses? Are there other factors
that explain the situation? Explain your response.
ANSWER 3: While most analysts agree that following the signing of NAFTA, the United
States saw some blue-collar jobs move to Mexico where wages were lower, they also
LECTURE OUTLINE
This lecture outline follows the Power Point Presentation (PPT) provided along with this
clicking on “view,” then on “notes.” The following provides a brief overview of each
Power Point slide along with teaching tips and additional perspectives.
Slides 6-3 ‒ 6-7 The Benefits of Trade
Free trade refers to a situation where a government does not attempt to influence
through quotas or duties what its citizens can buy from another country or what they can
produce and sell to another country.
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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International trade allows a country to specialize in the manufacture and export of
products that it can produce efficiently, and import products that can be produced more
The various theories have differing prescriptions for government policy on trade.
Mercantilism makes a crude case for government involvement in promoting exports and
limiting imports. Smith, Ricardo, and Heckscher-Ohlin promote unrestricted free trade.
New trade theory and Porter’s theory of national competitive advantage justify limited
and selective government intervention to support the development of certain export-
It views trade as a zero-sum game—one in which a gain by one country results in a loss
by another.
Another Perspective: An interesting perspective of how the mercantilist philosophy may
be a hindrance to trade negotiations between the United States and the European Union
efficiently.
If Ghana were to specialize in cocoa production and South Korea in rice production,
Smith argued that both Ghana and South Korea could consume more cocoa and rice than
if each only produced for their own consumption. Thus, trade is a positive sum game.
Slides 6-11 ‒ 6-19 Comparative Advantage
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The simple example of comparative advantage presented in the text makes a number of
assumptions: only two countries and two goods; zero transportation costs; similar prices
The simple model of comparative advantage assumes constant returns to specialization.
A more likely scenario is diminishing returns to specialization where after some point,
the more of a good that a country produces, the greater will be the units of resources
required to produce each additional item. If crops are grown on increasingly less fertile
land, mining is done on less productive ore, or less skilled personnel need to be hired to
might increase a country’s stock of resources as increased supplies become available from
abroad. Secondly, free trade might increase the efficiency of resource utilization, and free
up resources for other uses.
Another Perspective: An overview of the ideas and philosophies of David Ricardo, from
which his theory of comparative advantage emerged, is available at
Slides 6-20 ‒ 6-21 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. It focuses on differences in
relative factor endowments rather than differences in relative productivity.
known as the Leontief Paradox.
Slides 6-22 ‒ 6-23 The Product Life Cycle
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Raymond Vernon suggested that as products mature, both the location of sales and the
optimal production location will change, affecting the direction and flow of imports and
for other firms.
New trade theory does not contradict the theory of comparative advantage, but instead
identifies a source of comparative advantage.
A nation may be able to specialize in producing a narrower range of products than it
would in the absence of trade, yet by buying goods that it does not make from other
New trade theory suggests that nations may benefit from trade even when they do not
differ in resource endowments or technology.
The theory also suggests that a country may predominate in the export of a good simply
because it was lucky enough to have one or more firms among the first to produce that
good.
conditions; relating and supporting industries; and firm strategy, structure, and rivalry.
These attributes form Porter’s diamond.
Factor endowments are the nation’s relative position in factors of production. They are
divided into basic and advanced.
Demand conditions refer to the nature of home demand for the product or service, and
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Firm strategy, structure and rivalry refer to the conditions in the nation governing how
companies are created, organized, and managed, and how the nature of domestic rivalry
impacts firms’ competitiveness.
Firms that face strong domestic competition will be better able to face competitors from
other firms.
In addition to these four main attributes, government policies and chance can impact any
of the four. Government policy can affect demand through product standards, influence
rivalry through regulation and antitrust laws, and impact the availability of highly
educated workers and advanced transportation infrastructure.
Slide 6-34 Implications for Managers
There are at least three main implications of the material discussed in this chapter for
international businesses: location implications, first-mover implications, and policy
implications.
From a profit perspective, it makes sense for a firm to disperse its various productive
activities to those countries where, according to the theory of international trade, they can
be performed most efficiently.
Being a first mover can have important competitive implications, especially if there are
economies of scale and the global industry will only support a few competitors. Firms
need to be prepared to undertake huge investments and suffer losses for several years in
order to reap the eventual rewards.
Being a first mover can have important competitive implications, especially if there are
economies of scale and the global industry will only support a few competitors.
sale of products into the most competitive markets, it has a good chance to survive and
prosper. If such openness is restricted, a business’s long-term survival will be in greater
question.
Another Perspective: For information about foreign governments and their approaches to
international trade, visit the Electronic Embassy at {http://www.embassy.org/}. This site
provides links to all of the foreign embassies located in Washington D.C.
Balance of Payments