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Chapter Six
International Trade and Factor-
Mobility Theory
International Business
Part Three
Theories and Institutions: Trade
and Investment
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Chapter Objectives
To understand theories of international trade
To explain how global efficiency can be
improved through free trade
To identify factors affecting national trade
patterns
To explain why a countrys export capabilities
are dynamic
To understand why production factors
To explain the relationship between foreign
trade and international factor mobility
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Laissez-Faire versus Interventionist
Approaches to Exports & Imports
Interventionist:
Mercantilism
Neomercantilism
Free-trade theories:
Absolute advantage
Comparative advantage
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Theories of Trade Patterns
Explaining trade patterns:
Country size
Factor proportions
Country similarity
Trade competitiveness:
Product life cycle theory
Porter diamond
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Mercantilist Theory
Mercantilist theory proposed that a country
should try to achieve a favorable balance
of trade (export more than it imports)
Neomercantilist policy also seeks a
favorable balance of trade, but its purpose
is to achieve some social or political
objective
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Theory of Absolute Advantage
Suggests specialization through free trade
because consumers will be better off if
they can buy foreign-made products that
are priced more cheaply than domestic
ones
A country may produce goods more
efficiently because of a natural advantage
or because of an acquired advantage

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Theory of Comparative Advantage
Also proposes specialization through free
trade because it says that total global
output can increase even if one country
has an absolute advantage in the
production of all products
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Theories of Specialization
Both absolute and comparative advantage
theories are based on specialization
Assumptions policymakers question:
full employment
economic efficiency
division of gains
transport costs
statics and dynamics
services
production networks
mobility
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Trade Pattern Theories
How much a country will depend on trade
if it follows a free trade policy
What types of products countries will
export and import
With which partners countries will primarily
trade
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Theory Of Country Size
Countries with large land areas are apt to
have varied climates and natural
resources
They are generally more self-sufficient
than smaller countries are
Large countries production and market
centers are more likely to be located at a
greater distance from other countries,
raising the transport costs of foreign trade

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Factor-Proportions Theory
A countrys relative endowments of land,
labor, and capital will determine the
relative costs of these factors
Factor costs will determine which goods
the country can produce most efficiently
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Country-similarity Theory
Most trade today occurs among high-income
countries because they share similar market
segments and because they produce and
consume so much more than emerging
economies
Much of the pattern of two-way trading partners
may be explained by cultural similarity between
the countries, political and economic
agreements, and by the distance between them
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Product Life Cycle (PLC) Theory
Companies will manufacture products first
in the countries in which they were
researched and developed, almost always
developed countries
Over the products life cycle, production
will shift to foreign locations, especially to
developing economies as the product
reaches the stages of maturity and decline
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The Porter Diamond
Four conditions as important for
competitive superiority:
demand conditions
factor conditions
related and supporting industries
firm strategy, structure, and rivalry
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Limitations of the Porter Diamond
Theory
Production factors and finished goods are
only partially mobile internationally
The cost and feasibility of transferring
production factors rather than exporting
finished goods internationally will
determine which alternative is better
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The Relationship
between Trade and Factor Mobility
Capital and labor move internationally to
gain more income and flee adverse
political situations
Although international mobility of
production factors may be a substitute for
trade, the mobility may stimulate trade
through sales of components, equipment,
and complementary products