Presentation on

Trade Theories for International

Business
Rupali Dhavale (A)(06)
Ajay Jain (A)(11)
Bhagyashree Lad (A)(16)
Jeevitha Reddy (A)(25)
Naina Mahavar (B)(06)
Jyoti Jadhav (B)(07)

Nachiekaet Khaadey
(B)(11)
Pranav Mahaddalkar
(B)(12)
Hemanshu Patel (B)(23)
Dipesh Rao (B)(27)
Aakanksha Surve (B)(39)

International Trade

International trade is the exchange of goods and

services between countries

Trading globally gives consumers and countries the

opportunity to be exposed to goods and services

not available in their own countries

Significance of International Trade

A country may import things which it cannot

produce

Maximum utilization of resources

Benefit to consumer

Reduces trade fluctuations

Utilization of Surplus produce

More employment could be generated

Promotes efficiency in production

International Trade Theories

2000

National
competitive
advantage
New Trade
Theory

Product life
cycle

1990
1980
1970

Industrial
revolution

1960

1939- WW2
1945
1914- WW1
1918

Absolute
advantage

Mercantilism

Comparative
advantage

1) Comparative Advantage Theory

A famous economist named
David Ricardo (1772-1823)
came up with the law of
comparative advantage.
According to this law,
specialization and free trade
benefits all trading partners.
Countries should specialize
in those goods they have a
comparative advantage in.

Cont.

The country should import the goods it

produces less efficiently, even if it can produce
that good all by itself.
Due to increased efficiency (better use of
limited resources), potential world production is
greater with unrestricted free trade.
Comparative Advantage maximize countries
combined output
A country has a comparative advantage if it
can produce something at a lower cost than
others

Underlying Assumptions of
Comparative Advantage
Ricardo explains his theory with the help of following
assumptions : There are two countries and two commodities
Labor is the only factor of production other than
natural resources
Labor is perfectly mobile within a country but
perfectly immobile between countries
There is no technological change
Trade between two countries takes place on barter
system
There is no transport cost

What determines comparative

advantage?

The quantity and quality of factors of production

available

Investment in research & development

Movements in the exchange rate

Long-term rates of inflation

Import controls such as tariffs and quotas

Non-price competitiveness of producers

Merits of Comparative Advantage

Theory

International trade is possible even when a country

is able to produce all goods at cheaper cost

The country can produce more of those goods than

it needs and export them to other countries

Total production of goods will be increased

Country could increase its income

Demerits of Comparative Advantage

Theory

Transport costs may outweigh any comparative

advantage

Increased specialization may lead to diseconomies

of scale

Governments may restrict trade

Comparative advantage measures static

advantage but not any dynamic advantage

2) Competitive Advantage Theory

Economist Michael Porter, first
defined national competitive
advantage (NCA) in his 1990
book The Competitive
Advantage of Nations
NCA is basically an evaluation
of how competitively a nation
participates in international
markets
The two types of competitive
advantage an organization can
achieve relative to its rivals:
lower cost or differentiation.

Competitive advantage strategies

Porters Stages of
National Competitive Development

There are 4 drivers of Development

1)

Factor Condition

2)

Investment

3)

Innovation

4)

Wealth

Forces Influencing Competitiveness

The model of the Five Competitive Forces was

developed by Michael E. Porter in his book
Competitive Strategy: Techniques for Analysing
Industries and Competitors in 1980.

IKEA

COCO-COLA

McDonald.

Porters Diamond-Shaped Framework

Factor Conditions

For example, Japan is a small nation that lacks

enough land fit for agriculture; in order to make up
for this and become more competitive in the
international markets, however, Japan has
exploited its wealth of human resources to become
a global leader in technology.

Demand Conditions

For example, if there is a high demand for the

iPhone in the U.S., Apple will be more willing to
work on improving its design and thus do better in
not only the U.S. market, but the international
market as well.

Related and Supporting Industries

For example, the success of the automobile

industry not only benefits the industries of its
suppliers (e.g. metal, leather, rubber), but also
industries that are directly linked to automobiles
(e.g. car insurance).

Firm Strategy, Structure, and Rivalry

For example, the rivalry between iPhones and

Androids in the Smartphone market is healthy
because this incites innovation on either side and
makes both companies key players in providing the
U.S. with a high-ranking NCA.

3) Purchasing Power Parity

Theory

Purchasing power parity

Is a real value comparison between two
currencies

It means we should able to purchase same

amount of goods in either country
A bundle of goods should cost the same in
various countries

Example:
Product: Baseball Bat
1 $ = 60 Rs
India
600 Rs

US
40 $

Convert Rs to $
1$
60 Rs
10$
600Rs
Difference in cost = 30 $(40 $ - 10$)

Price was less In India

Quantity demanded

Cost of Product

1 $ = 50 Rs
India
1500 Rs

US
30 $

Convert Rs to $
1$
50 Rs
30$
1500Rs

Difference in cost = 0 $(30 $ - 30$)

Value of Rs

Purchasing Power Parity and the Long Run

Price differentials between countries are not
sustainable in the long run
An individual or company will be able to gain
an arbitrage profit by buying the good cheaply in one
market and selling it for a higher price in the other
market

Two Views of PPP

Absolute Purchasing Power Parity

Relative Purchasing Power Parity

Absolute Purchasing Power Parity

Exchange rate between two countries will be identical to

the ratio of the price levels for those two countries.

This concept is derived from a basic idea known as the

law of one price, which states that the real price of a
good must be the same across all countries.
The following conditions must be met for this relationship
to be true:
The goods of each country must be freely tradable
on the international market.

The price index for each of the two countries must be

comprised of the same basket of goods.

All of the prices need to be indexed to the same year.

Formula

S= P P*
Where,

S is the spot exchange rate between two countries

(the rate of the amount of foreign currency needed
to trade for the domestic currency).

P is the price index for a domestic country.

P* is the price index for a foreign country.

Example:

Soybeans are currently priced at $5 a bushel in

the U.S., that soybeans are priced at 5.50 per
bushel inEurope, and that the exchange rate is
1.10 euros per dollar. Suppose that the price of
soybeans goes up to 6.05 per bushel (a 10%
increase) in Europe, while the price of soybeans in
the U.S. only goes up on 5%, to $5.25 a bushel. If
there is no depreciation in the euro to offset the 5%
difference, then European soybeans will not be
competitive on the international market and trade
flowing from the U.S. to Europe will greatly
increase.

Problems with Absolute PPP

Absolute PPP may not hold due to:

Transportation costs and tariffs are present.
National price indexes capture the prices of goods
that are not traded internationally.
Changes in the exchange rate may be due to real
rather than nominal economic events. Real events,
such as relative price changes resulting from a poor
harvest, may cause deviations from absolute PPP
as the exchange rate changes, even if the price
indexes remain constant.

Relative Purchasing Power Parity

Relative PPP states there is a correlation between

price-level changes between two countries and
currency exchange rates.

Relative PPP maintains that though the price for

the same item varies in different countries, the
percentage of the difference is relatively the same
over a longer period.

The percentage of appreciation or depreciation of

currencies is equal to the percentage difference
between the two country's inflation rates.

Formula

S1 / S0 = (1 + Iy) (1 + Ix)

Where,
S0 is the spot exchange rate at the beginning of the time
period (measured as the "y" country price of one unit of
currency x)

S1 is the spot exchange rate at the end of the time

period.

Iy is the expected annualized inflation rate for country y,

which is considered to be the foreign country.

Ix is the expected annualized inflation rate for country x,

which is considered to be the domestic country.

Example
Ex 1: Suppose that the annual inflation rate is expected to
be 8% in the Eurozone and 2% in the U.S. The current
exchange rate is $1.20 per euro (1.00 = $1.20). What
would the expected spot exchange rate be in six
months for the euro?

Ex 2: Assume that the U.S. is the foreign country and

that Japan is the domestic country. The current spot
exchange rate is S0 = 115 yen per dollar ($1 per
115.00). The expected annual inflation rate for
the U.S. is 4.89%, and the annual expected Japanese
inflation rate is 6.23%. Compute the approximate
expected spot rate and the expected spot rate one year
from now.

4) Product Life Cycle Theory

The product life-cycle

theory is an economic
theory that was developed
by Raymond Vernon

After the product becomes

adopted and used in the
world markets, production
gradually moves away
from the point of origin

Stages of Product Life

Cycle

Stages of Product Life

Cycle
Introduction
New product launched on the market
Low level of sales
Low capacity utilization
Usually negative cash flow
Heavy promotion to make consumers
aware of the product
1)

Stages of Product Life

Cycle
2) Growth
Cash flow may become positive
The market grows, profits rise but
attracts the entry of new competitors
Advertising to promote brand
awareness
Increase in distribution outlets
Improve the product - new features,
improved styling, more options

Stages of Product Life

Cycle
3) Maturity
High profits for those with high market
share
Cash flow should be strongly positive
Weaker competitors start to leave the
market
Slower sales growth as rivals enter the
market
Prices and profits fall

Stages of Product Life

Cycle
4) Decline
Falling sales
Market saturation and/or competition
Decline in profits & weaker cash flows
More competitors leave the market
Decline in capacity utilization

International changes during a

Product Life Cycle
Introduction

Growth

Maturity

Decline

1) Product
Location

In
innovating
country

In
Multiple
innovating
countries
and other
industrial
country

Mainly in
LDCs

2) Market
Location

Mainly
within the
country,
with some
export

Mainly in
Growth in
industrial
LDCs
country
Some in
Shift in
industrial
export
countries
market as
foreign
production
replaces
exports in
some
markets

Mainly in
LDCs
Some
LDC
export

International changes during a

Product Life Cycle
3)
Competitiv
e Factors

Introduction

Growth

Near
monopoly
position
Sales
based on
uniqueness
rather than
price
Evolving
product
Characteris
tics

Fast
growing
demand
Number of
competitor
s increase
Some
Competitor
s being
pricecutting
Product
becoming
more
Standardiz
e

Maturity

Decline

Overall
Overall
stabilize
decline
Number of
demand
competitors Price is a
decrease
key
Price is
weapon
very
Number
important
of
especially
Producer
in LDCs
Continue
s to
decrease

International changes during a

Product Life Cycle
Introduction

Growth

Maturity

4)
Short
Capital
Long
Production
Production
input
production
Technolog
run
increases
run using
y
Evolving
Methods
high
methods to
are more
capital
coincide
standardiz
income
with product
e
Highly
evolution
standardiz
High labor
e
and labor
Less labor
skills
skill
relative to
needed
capital input

Decline
Unskilled
labor on
mechaniz
ed long
run
productio
n

Things Needed for International

Product Life Cycle
1)
2)
3)
4)

The structure of the demand for the

product
Manufacturing
International competition
and marketing strategy
The marketing strategy of the
company that invented or innovated
the product

Stages from the initiating

country view point
Product
Stage

Trade

Target
Market

Competitors

Production
Cost
Locally

New

Limited
production
for home
market

Inventors
country

few local
firms

Initially high

Mature

Increasing
exports

Inventors
country and
later
developing
markets

competitors
from
advanced
markets

Declining
due to
economies
of scale

Inventors
country

Competitors
from mostly
developing
markets

Lower
economies
of scale and
comparative
disadvantag
es

Standardizatio Declining
n
export at
first, later in
phase
become
imports

Pros of International Product

Life Cycle
The model helps organisations that
are beginning their international
expansion
According to Vernon, most managers
are myopic
The IPLC model was widely adopted
as the explanation of the ways
industries migrated across borders
over time

Cons of International Product

Life Cycle
It is difficult to determine the phase of
a product in product life cycles
He used the product side of the
product life cycle, not the consumer
side
Selling older products to a lesser
developed market does not work if
transportation costs for imports is low

Any Questions