Theories of International Business

Comparative Cost Theory Opportunity Cost Theory Factor Endowment Theory Other
Theory of Absolute Different Cost The Productivity Theory The Vent for Surplus Theory Mills Theory of Reciprocal Demand

Comparative Cost Theory.....

Given by David Recardo in 1817, used two country, two commodity model. Business b/w 2 countries is profitable when a country produces a good at lower price than other country. One country produces more than one product efficiently but one product more efficiently. Business b/w 2 nations only when a country specializes in the production in which it has greater efficiency.

Comparative Cost Theory.....

The factors offering this advantage are:

cheap &/or skilled labour, advanced technology, qualitative raw material, competent mgmt practices, etc.

For Ex:
Japan has advantage in producing electronic items at low cost whereas India has an advantage in textiles.

Comparative Cost Theory.....

Assumptions:

Only element of cost of production is Labour No Trade Barriers No Transportation Cost

Derivations:

Efficient allocation of global resources Almost equal product prices in world market. Demand optimization of products *****

Opportunity Cost Theory

Proposed by Gottfried Haberler 1959 Opportunity cost is the value of alternatives which have to be foregone in order to obtain another particular thing.
For ex: Rs. 1000 invested in equity & earned 6%. The opportunity cost of this investment is 10% interest if deposited in bank for 1 year.

Opportunity Cost Theory

Specifies the cost in terms of the value of the alternatives which have to be foregone in order to fulfill a specific act. Provides the basis for international business of exporting a product to a particular country rather than to another country.

Factor Endowment Theory

Bertil Ohlin & Eli Heckscher Explains the reasons of comparative cost differences. A country will specialize in the production & export of those goods whose ratio b/w capital & other factors of production is higher than those in other countries.
For ex: Crude Oil in Gulf Countries

Factor Endowment Theory

Assumptions:
Free Trade No Transportation cost Factor of production vary from country to country Other factors of production are of equal quality & perfectly mobile between the countries.

Factor Endowment Theory

Merits:
Superior than Comparative Cost Theory as it provide basis for differentiation in cost of production. Provides more valid basis for the existence of international business than other theories. Indicates the impact of international business on product & factor prices.

Other Theories

Theory of Absolute Different Cost:

Adam Smith produce only those products which they can produce at lowest price and exchange them with the products of other countries produced at lowest prices. Criticism:

Most of the developing countries are unable to produce googds at lowest cost.

Other Theories

The Productivity Theory:

Emphasizes on adapting & reshaping production structure of a trading country to meet the export demands. Encourages the developing countries to go for cash crops & adapting latest technology.

Limitations of Productivity Theory

Labour productivity do not increase after certain level. Increase in working hours to meet export demands. Limited skilled labour.

Other Theories

The Vent for Surplus Theory

If the countries produce more than domestic demand, they have to export the surplus to other countries. This surplus gives the benefits under international trade. Also known as Surviving Relic of the Mercantile Theory (J.S. Mill)

Other Theories

Mills theory of Reciprocal Demand

Indicates a countrys demand for a commodity in terms of other commodity, it is prepared to give in exchange. Reciprocal demand determine the term of trade & relative share of each country.