International Marketing

Trade theories
INTRODUCTION
• The reason for the emergence of international trade is that human
wants are varied and unlimited
• No single country possesses the adequate resources to satisfy all
these wants
• Hence there arises a need for interdependence between countries in
the form of international trade
• So in order to make effective utilisation of the world’s resources
international trade is a must
BASIS OF INTERNATIONAL TRADE

• No country is self sufficient in producing all the required goods and

services from its own resources.
• This problem can be solved through international trade where the
countries obtain those goods which it cannot produce or cannot
produce as cheaply as possible in another country.
• However this is not the only basis for doing international trade, there
are other reasons also.
• Trade economists have laid down different theories for international
trade.
Contd….
• Theory of absolute cost advantage
• Theory of comparative cost advantage
• Factor endowment theory
• Theory of competitive advantage
• Product life cycle theory
• Theory of identical preferences
• Product differentiation
• Outlet for domestic surplus
THEORY OF ABSOLUTE COST ADVANTAGE (By Adam
Smith)
• Producing a good with fewer inputs (capital, labor, land, raw
materials, etc.) per unit of output than other countries
• If input prices are the same in two countries, the country with an
absolute advantage in a good will have a lower unit cost of production
for that good
• A country should produce and export products in which it has an
absolute advantage
•A country should import products in which it has an absolute
disadvantage
Per unit cost of production( Rs.)
• India has absolute
Country Cotton Tea cost advantage in
the production of
cotton and
India 5 10 Indonesia in the
production of tea
• Both countries will
gain if India
produces and
Indonesia exports cotton and
10 5 Indonesia produces
and exports tea.
THEORY OF COMPARATIVE COST ADVANTAGE (By David
Ricardo)
• Focus on comparative cost advantage not on
absolute cost advantage.
• Each country specialises in the production of
that commodity in which its comparative cost of
production is the least.
• A country will export those commodities in
which its comparative costs are less.
• A country will import those commodities in
which its comparative costs are high.
 Commodities (Per unit cost of production)

• Country Y has
Country
A B C D E comparative advantage in
products B and C
• Country Y will put all its
X 10 12 13 14 15 resources in the
production of B and C
• Country X will produce
Y 9 5 8 13 14 other products i.e. A, D,
and E.

Cost 1 7 5 1 1
Difference
FACTOR ENDOWMENT THEORY (By Heckscher and
Ohlin)
• A country that is relatively abundant in a factor of
production should export goods that use a lot of that
factor in the production process, and import other
goods

• Example: a country like China with a lot of labour

should export labour-intensive goods

• Why? If a factor is relatively abundant, it will be

relatively cheap, and a country will be more globally
competitive in products that use a lot of that factor
THEORY OF COMPETITIVE ADVANTAGE (By Micheal
Porter)
• To compete in the world a country requires a strategy to gain a
competitive edge over the others.
• Competitive advantage is created by technological and institutional
change, not just inherited from a country’s natural endowments.
 Determinants of National Competitive
Advantage
• Factor endowments:nation’s position in factors of production
such as skilled labor or infrastructure necessary to compete in a
given industry.
• Firm strategy, structure and rivalry:the conditions in the
nation governing how companies are created, organized, and
managed and the nature of domestic rivalry.
• Demand conditions:the nature of home demand for the
industry’s product or service.
• Related and supporting industries:the presence or absence
in a nation of supplier industries or related industries that are
nationally competitive.
 Porter’s Diamond
Determinants of National Competitive Advantage

Firm Strategy,
Structure and
Rivalry

Factor Endowments Demand Conditions

Related and
Supporting
Industries
PRODUCT LIFE CYCLE THEORY (By Vernon)

• Industrialised countries contribute more resources to research and

development which results in development of new products
• In early stage they have monopoly on such new products and enjoy
easy access to foreign markets
• Later other countries start imitating their products and initial
advantage disappears.
THEORY OF IDENTICAL PREFERENCES (By Linder)

• Based on the principle that trade opportunities are more among

countries at similar stage of development with similar demand
structure
• E.g. USA and Japan are largest trade partners because of identical
consumer preferences and similar stage of development.
PRODUCT DIFFERENTIATION

• Another reason or basis for international trade can be the product

differentiation.
• It means differentiating a product in some manner such as adding
different and new features in the same basic products.
OUTLET FOR SURPLUS
• Most countries involve in international trade because they have
surplus production
• Surplus commodities or some unused resources can be exported
• E.g. India had surplus wheat in 2000 and there was no additional
storage capacity, so it was decided to export wheat at cheaper rates
in the international market.