Explain the theories that attempt to explain why certain goods are traded internationally.

Why do nations trade? Mercantilists did so to build up storehouses of gold. Later, Adam Smith showed that a nation will export goods that it can produce with less labor than can other nations. Ricardo then proved that even though a country is less efficient than other nations, that country can still profit by exporting goods if it holds a comparative advantage in the production of those goods.
    The idea that a nation tends to export products requiring a large amount of a relatively abundant factor was offered by Heckscher and Ohlin in their theory of factor endowment. In the 1920s, economists realized that economies of scale affect international trade because they permit the industries of a nation to become low-cost producers without having an abundance of a class of production factors. As in the case of comparative advantage, nations specialize in the production of a few products and trade to supply the rest. The Linder theory of overlapping demand states that because customers' tastes are strongly affected by income levels, a nation's income level per capita determines the kind of goods they will demand. The kinds of goods produced to meet this demand reflect the country's income per capita level. International trade in manufactured goods will be greater between nations with similar levels of per capita income.
    The international product life cycle theory states that many products first produced in the United States or other developed countries are eventually produced in less developed nations and become imports to the very countries in which their production began. Krugman showed how economies of scale and imperfect competition can explain high levels of intraindustry trade. Marshall and Porter helped to explain how nations can achieve competitive advantage through the emergence of regional clusters, with Porter claiming that four classes of variables are critical in this regard: demand conditions, factor conditions, related and supporting industries, and firm strategy, structure, and rivalry.

Discuss the arguments for imposing trade restrictions.

Special-interest groups demand protection for defense industries so that their country will have these industries' output in wartime and will not depend on imports, which might not be available. Critics say that it would be far more efficient to subsidize some firms, that is, pay them to be ready. New industries in developing nations frequently request barriers to imports of competing products from developed countries. The argument is that the infant industry must have time to gain experience before having to confront world competition. Protectionists argue for protection from cheap imports by claiming that other countries with lower hourly labor rates than those in the protectionist's nation can flood the protectionist's nation with low-priced goods and take away domestic jobs. However, hourly labor rates are just a small part of production costs for many industries. There may be legislated fringe benefits that are a much higher percentage of the direct wages than is the case in developed nations. Productivity per worker may be considerably lower in developing nations, so less is produced for a given hourly rate. Commonly, also, the costs of the other factors of production that must be included in the cost of production often are higher in developing nations. Others want "fair" competition, that is, an import duty to raise the cost of the imported good to the price of the imported article to eliminate any "unfair" advantage that the foreign competitor may have. This, of course, nullifies the comparative advantage. Companies will also demand that their government retaliate against dumping and subsidies offered by their competitors in other countries.

Explain the two basic kinds of import restrictions: tariff and nontariff trade barriers.

In response to demands for protection, governments impose import duties (tariff barriers); nontariff barriers, such as quotas, voluntary export restraints, and orderly marketing arrangements; and nonquantitative nontariff barriers, such as direct government participation in trade, customs, and other administrative procedures and standards for health, safety, and product quality.

Appreciate the relevance of the changing status of tariff and nontariff barriers to managers.

Exporting firms may find that because tariff and nontariff barriers have been eliminated or lowered, they can now enter markets that were previously closed to them. It also is easier for firms to locate production activities in lower-cost nations to improve the efficiency of their manufacturing systems. Multidomestic firms may be able to close less efficient plants and supply those markets by exporting from more efficient ones.

Explain some of the theories of foreign direct investment.

International investment theory attempts to explain why foreign direct investment (FDI) takes place. Product and factor market imperfections provide firms, primarily in oligopolistic industries, with advantages not open to indigenous companies. The international product life cycle theory explains international investment as well as international trade. Some firms follow the industry leader, and the tendency of European firms to invest in the United States and vice versa seems to indicate that cross investment is done for defensive reasons. There are two financially based explanations of foreign direct investment. One holds that foreign exchange market imperfections attract firms from nations with overvalued currencies to invest in nations with undervalued currencies. The second theory postulates that FDI is made to diversify risk. Empirical tests reveal that most FDI is made by large, research-intensive firms in oligopolistic industries. The internalization theory states that firms will seek to invest in foreign subsidiaries, rather than license their superior knowledge, to receive a better return on the investment used to develop that knowledge. The dynamic capabilities perspective suggests that firms must have not only ownership of specific knowledge or resources but also the ability to dynamically create and exploit capabilities in order to achieve success in international FDI. The eclectic theory of international production explains an international firm's choice of its overseas production facilities. The firm must have location and ownership advantages to invest in a foreign plant. It will invest where it is most profitable to internalize its monopolistic advantage.