C H A P T E R 6
International trade
Chapter objectives
2. Contrast the theories of absolute advantage and comparative advantage.
4. Explain some of the most commonly used barriers to trade and other economic
developments that affect international economics.
5. Discuss some of the reasons for the tensions between the theory of free trade and the
widespread practice of national trade barriers.
Chapter summary
1. International trade is the branch of economics concerned with the exchange of goods and
2. A number of international trade theories help explain why nations trade. These include the
theory of absolute advantage, the theory of comparative advantage, the factor endowment
3. There are a number of different barriers to trade. Some of the most common include price–
4. Although tariffs are often introduced to maintain local jobs and assist infant industries, they
5. NTBs provide similar economic inefficiencies to tariffs. Unlike tariffs, however, NTBs are
not imposed by nations to interfere deliberately with trade; they arise out of domestic
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6. Countertrade is a form of barter trade in which the exporting firm receives payments in
terms of products produced in the importing country. This type of trade is most pronounced
7. Services are an important but somewhat misunderstood component of trade. Despite trade of
services in billions of dollars among high-income countries, the regulation of trade in
8. A free trade zone is a designated area where importers can defer payment of customs duty
while further processing of products takes place, thus becoming an offshore assembly plant.
The majority of these areas exist in developing countries, and they handle approximately 20
percent of worldwide trade. Free trade zones are advantageous to all because they provide
benefits such as increased employment and lower costs to business.
Chapter outline
Introduction
International trade theory
Theory of absolute advantage
Theory of comparative advantage
Barriers to trade
Reasons for trade barriers
Commonly used barriers
Tariffs
US trade policy
Nontariff barriers to trade
Quotas
Rugman and Collinson, International Business, 6th edition, Instructor’s Manual
Antidumping legislation, subsidies and countervailing duties
Agricultural products
Export restraints
Other economic developments
Lecture outline
A. Introduction
1. International trade is the branch of economics concerned with the exchange of goods
B. International trade theory
1. Why do nations trade? One of the earliest, and simplest, answers was provided by
2. The theory of absolute advantage holds that by specializing in the production of goods
they can produce more efficiently than anyone else, nations can increase their economic
3. The theory of comparative advantage holds that nations should produce those goods for
which they have the greatest relative advantage. Thus, there are gains from trade
4. In recent years, more sophisticated theories have emerged that help clarify and extend
knowledge of international trade. The factor endowment theory holds that countries will
produce and export products that use large amounts of production factors that they have
5. There are some weaknesses in the factor endowment theory. One is that some countries
have minimum wage laws that result in high prices for relatively abundant labor. As a
result, the country may find it less expensive to import certain goods rather than to
6. Another theory that provides insights into international trade is Vernons international
product life cycle (IPLC) theory. This holds that production of a product with new
7. The IPLC theory is useful in helping to explain how new, technologically innovative
products fit into the world trade picture. However, because innovative products are
8. Other factors that greatly influence trade theory include government regulation,
C. Barriers to trade
1. Some of the most common reasons for trade barriers include the following: (a) to
protect local jobs by shielding home-country business from foreign competition; (b) to
2. A variety of barriers deter the free flow of international goods and services. These include
(a) price-based barriers such as ad valorem tariffs; (b) quantity limits such as quotas;
3. A tariff is a tax on goods that are shipped internationally. The most common is the
import tariff, which is levied on goods shipped into a country. Less common is the
export tariff, which is levied on goods that are sent out of the country, or a transit tariff,
4. There are a number of reasons for using tariffs. One is to protect domestic industries or
D. Nontariff barriers to trade
1. Nontariff barriers (NTBs) have gained prominence in recent years, since they have
become more visible and more important. Some of these barriers are not imposed by
2. Quotas are the most important NTBs. A quota restricts imports to a particular level.
When a quota is imposed, domestic production generally increases and prices rise. In
3. Buy national regulations require national governments to give preference to domestic
4. During the GATT Tokyo Round, considerable progress was made in the area of
5. Product and process standards for health, welfare, safety, quality, size and
measurements can create trade barriers by excluding products that do not meet the
6. The GATT and the World Trade Organization (WTO) allow importing countries to
protect their producers from unfair competition such as dumping goods at extremely
7. Trade in agricultural products is highly regulated by quotas and by fixed and variable
8. Over the vigorous objections of countries exporting natural resources, the GATT rounds
moved to tighten the conditions under which exports could be restrained. During these
rounds, natural-resource-producing countries were largely unsuccessful in their attempts
Rugman and Collinson, International Business, 6th edition, Instructor’s Manual
E. Other economic developments
2. Countertrade is essentially a form of barter trade in which the exporting firm receives
payment in terms of products from the importing country. Countertrade forms a major
3. As high-income countries have moved toward a service economy, trade in services has
grown and become a significant component of the current accounts of many countries.
4. A free trade zone, or foreign trade zone, is a designated area where importers can defer
payment of customs duty while further processing of products takes place. Thus, it
serves as an offshore assembly plant, employing local workers and using local finance
Answers to review and discussion questions
1. Why is it difficult to solve international economic problems in the short run?
2. What is the supposed economic benefit of embracing mercantilism as an international
trade theory? Are there many disadvantages to the use of this theory?
3. How is the theory of absolute advantage similar to that of comparative advantage?
How is it different?
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4. In what way does factor endowment theory help to explain why nations trade? How
does the Leontief paradox modify this theory?
The factor endowment theory holds that nations produce and export products that use large
amounts of production factors that they have in abundance and import products that require
5. If an innovating country develops a new technologically superior product, how long
will it be before the country begins exporting the product? At what point will the
country begin importing the product?
6. Of what value is the international product life cycle theory in helping to understand
why nations trade?
The international product life cycle is helpful in understanding why nations trade because it
explains why countries that start out as exporters of a particular product will eventually become
7. How does each of the following trade barriers work: price-based barriers, quantity
limits, international price fixing, nontariff barriers, financial limits and foreign
investment controls?
A price-based barrier is one that adds a tariff to an imported good. Quantity limits are
restrictions on the number of items that can be imported; examples include quotas and
embargoes. International price fixing is a cartel-type arrangement in which producers or sellers
8. What are some of the reasons for trade barriers? Identify and describe five.
9. How does the US try to encourage exports? Identify and describe two ways.
10. Nontariff barriers have become increasingly predominant in recent years. Describe a
nontariff barrier, and list four types, explaining how the US does or could use such a
device.
11. How does countertrade work? Is it an efficient economic concept?
Countertrade is a form of barter trade in which the exporting firm receives payment in the form
of products from the importing country. For example, a Western firm may sell Russia oil-
12. What is a free trade zone? Is it an efficient economic concept?
13. What are two future problems and challenges that will have to be addressed by the
international monetary system? Describe each.
14. What is meant by the term balance of payments?
15. What are the three major accounts in the balance of payments?
16. How would the following transactions be recorded in the IMF balance of payments?
(a) Dell in the United States has sold an $8 million computer to an insurance company in
Answers to real cases
Job losses and offshoring to China
1. Does the theory of comparative advantage apply to Chinas trade with industrialized
countries? How?
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2. How does the factor endowment theory apply to Chinas trade with industrialized
countries?
3. Are any of the countries mentioned operating in autarky?
4. How can distribution of gains from free trade cause much of the political debate
regarding trade with China?
Trade creates winners and losers. For example, exporters to China win by having a trade
Dumping on trade complaints
1. Why are antidumping (AD) and countervailing duty (CVD) measures brought and
imposed?
2. What is the impact on a firm from a nontriad country if it faces an AD or CVD case in
its major market?
3. What is the solution to the abusive use of AD and CVD measures by triad economies?