LESSON 13: COUNTRY SIMILARITY THEORY

Traditional trade theories speak of differences in resources and demand

or supply conditions as necessary condition for trade between countries.
In contrast,
the country similarity theory is built upon similarities or identical
features of nations for them to trade with each other.
The country similarity theory was developed by Swedish economist
Steffan Linder in 1961, as he tried to explain the concept of intra-
industry trade. Simply, this theory describes the idea that countries with
comparable qualities are mainly likely to trade with each other. These
qualities might include the stage of development, per capita income,
savings rate, natural resources, cultural milleu, geographical features,
political and economic interests, and the like.
TWO TYPES OF TRADE
Inter-industry trade
Trade between and among different industries
Intra-industry trade
Trade between and among the same industry.

To determine the similarity of countries, the Geert-Hofstede model is a

tool that was developed to compare countries. This model uses six
dimensions to compare countries:
 a. Power distance. It is power in the country distributed unequally.
b. Individualism. It is the degree of interdependence of the members
of a society.
c. Masculinity. It is the want to be the best versus liking what you do
(feminine).
d. Uncertainty avoidance. Are members of a society feeling
threatened by unknown situations?
e. Long-term orientation – the society has links with the past and
deals with the challenges of the present and the future
f. Indulgence -do members of society control their impulses and
desires.

LESSON 12: PORTER’S NATIONAL

COMPETITIVE ADVANTAGE THEORY
Competitive advantage refers to the ability of the country or company to
offer greater value to customers, either by means of lower prices, or
offering more benefits and services at the same price.

FIGURATIVELY SPEAKING:
Cost Advantage + Quality Assurance
= Competitive Advantage

Michael Porter of Harvard Business School introduced a new model in

his book. The Competitive Advantage of Nations, known as Porter’s
Diamond. Porter’s theory stated that a nation’s competitiveness in an
industry depends on the capacity of the industry to innovative and
upgrade.

Michael Porter identified four stages of development in the evolution of

a country:
A. Development based on (production) factors
B. Development based on investments (capital)
C. Development based on Innovation (creativity)
D. Development based on prosperity (economic growth and
development)

To explain this theory, Porter identified four determinants that he linked

together to form Porter’s diamond:
a. Local market resources and capabilities;
b. Local market demand conditions;
c. Local suppliers and complementary industries; and
d. Local firm characteristics.
Porter added to these basic production factors (land, labor, and capital) a
new list of advanced factors:

A . Human resources, including skilled labor

B . Material resources, including natural resources, vegetation, space,
and the like.
C . Investments in education, including knowledge and research on
universities
D . Technology
E . Infrastructure

Porter’s competitive advantage chain value shows how a company

attains competitive advantage through its main activities that provide
cost advantage and the support activities that will provide the firm
quality knowledge.

LESSON 14: PRODUCT LIFE CYCLE

INTRODUCTION STAGE SALES IS LOW -AWARENESS

GROWTH STAGE SALES UP-Many customer are aware
MATURITY STAGE. SALES OF YOUR PRODUCT
ALREADY REACHITS MAXMUM LIMIT YOU DON’T ACQUIRE
NEW CUSTOMERS
DECLINE STAGE. SALES DOWN
Life cycle is the series of stages through which a living thing passes
from the beginning of its life until its death.
The term product life cycle refers to the length of time a product is
introduced in the market until it is removed from the shelves.

The product life cycle theory is a marketing strategy developed by

Raymond Vernon in 1966 to help companies plan out the progress of
their new products and explain the pattern of international trade and
foreign direct investment, which follows the product life cycle.

The product life cycle theory is a marketing strategy developed by

Raymond Vernon in 1966 to help companies plan out the progress of
their new products and explain the pattern of international trade and
foreign direct investment, which follows the product life cycle.

Vernon explained that form the invention of a product to its demise due
to lack of demand, a product goes through four stages: introduction,
growth, maturity, and decline. The length of each stage can vary from
product to product. Many factors go into determining how quickly a
product goes through the four stages, including how the product is
marketed, the demand for the product, and the product itself.
Product life cycle management (PLM) is the process of managing a
product’s life cycle form inception, through design and manufacturing to
sales, service, and eventually, retirement.
Prior to a product being introduced to the market, companies conduct
research on which product is in demand, how to produce the product,
and conduct market tests to see if the product will sell. If the results of
these researches and tests are positive, that is the time the company will
begin production and the product will be introduced to the market.

At the stage growth, demand for the product beings to increase and
sales usually grows exponentially from the takeoff point. At this stage,
profitability reaches the highest level. Economies of scale are now in
order as sales revenue increases faster than costs and production reaches
capacity.

At the maturity stage, sales increase continues in a decreasing pattern,

but the sales curve tends to decrease after the top selling point is
reached. There is intense competition and product differentiation and
generating brand awareness becomes a must. Retaining customer brand
loyalty is the key. The biggest challenge is maintaining profitability and
preventing sales form further decline.

A product enters the decline stage when no amount of marketing or

promotion can keep the sales figures from declining. Other innovative or
substitute products that satisfy customer needs better have entered the
market. Sales likely continue until the cost to produce the product rises
higher than the profits generated from it.

Some of the strategies that can be employed in the decline stage are:
 a. Making or harvesting, which means reducing marketing efforts and
attempt to maximize the life of the product for as long as possible;
b. Slowly reducing distribution channels and pulling the product from
under performing geographic areas allowing the company to pull
the product out and attempt to introduce a replacement product;
and
c. Selling the product to a niche operator or subcontractor to allow
the company to dispose of a low-profit product, while retaining
loyal customers.

LESSON 15: THE SPECIFIC FACTOR MODEL

Trade raises real incomes trading countries. Real income is simply

inflation- adjusted income, measure the amount disposable income
Available to consumer.
The gross national income (GNI) is the sum of the value added by all the
goods and services produced within a particular country, including
foreign investment, to which are added any product taxes (excluding
subsidies) and the value earned by the through overseas ventures.
There are at least reasons why trade has an important influence upon the
income distribution: a. Resources (factors of production: land, labor, and
capital) cannot be transferred immediately and without cost from one
industry to another. 8. Industries use different factors and a change in the
production mix a country offers will reduce the demand for some of the
production factors
A factor of production Is any resource that is used by firms to produce
goods and services. The specific factor (SF) model was originally
advanced by Jacob Viner and it is variants of the Ricardian Model. The
Ricardian Model of trade was developed by English political economist
David Ricardo in his magnum opus on the Principles of Political
Economy and Taxation (1817). It is the first formal model of
International trade

Paul Samuelson and Ronald Jones, two American economist,

elaborated the SF model based on specific factors, which are, in fact, the
factors of production-land, labor, and capital, Jones and samuelson
decided to call these factors territory or terrain (T) (terra means land).
Labor (L), and capital (K).
Jones and Samuelson say that products like food (x) are made by using
territory (T) and labor (L), while manufactured products (Y) use
capital (K) and labor (L). Labor (L) is a mobile factor, one that can be
used in both food and manufactured products. Territory and capital are
specific factors, territory (T) is used only for food and capital is used
only for manufactured products.
When labor moves from food to manufactured product, food production
falls while output of the manufactured products rises. The shape of the
production function reflects the law diminishing marginal returns.
The law of diminishing marginal returns is a theory in economics that
predicts that after some optimal level of capacity is reached, adding an
additional factor of production will actually result in smaller increases
in output.
Therefore, a country rich in capital and poor in land tends to produce
more manufactured products than food products, whatever the price. A
country rich in land (territory), like most agricultural countries, tends to
produce more food.

Other factors held constant an increase in capital will mean an increase

in marginal productivity from the manufactural sector, while an increase
in territory will increase the production of food.
It is, therefore, important for those countries rich in capital and those
countries rich in territory to trade with each other.

LESSON 16: Standard Model of Trade

The standard model of trade (Paul Krugman-Maurice Obsfeld model)
implies the existence of the relative global demand curve resulting from
the different preferences for a certain good and relative global supply
curve resulting from the different production possibilities.
According to Paul Krugman and Maurice Obsfeld, the exchange rate, the
rapport between the export prices and the import prices, is determined
by the intersection between the two curves, which is the equilibrium.
Relative prices determine the economy’s output. Other factors being
constant, the exchange rate improvement for a country implies a
substantial rise in the welfare of that country.
Global demand or total demand refers to amount of money, which
subjects (consumers) of an economy plan to spend on goods and services
at the different size of income or at given prices in a given period. Total
demand consists of personal consumption of households and individuals,
gross private domestic investment by business, gross government
spending, and net export.

Net exports are a measure of nation’s total trade. The formula for net
exports is a simple one: the value of a nation’s total export goods and
services minus the value of all the goods and services it imports equal its
net exports.

Market equilibrium is the intersection of the global demand curve and

the global supply curve. Market/economy equilibrium means that the
national product and level of prices are shaped on the level on which
buyers are willing to buy what enterprises are ready to sell.

The aggregate demand curve shows how many goods and services
consumers can and are willing to buy at different total price levels, other
conditions remaining the same. The size of purchases made by
consumers influences prices. The size of global demand changes the
level of prices inversely. The crucial factor is the elasticity of global
demand in relation to interest rates or level of global wealth.

The supply curve represents the relationship between price and quantity
supplied, with all other factors affecting supply held constant. Quantity
supplied (supply curve) is a function of price. A shift in the supply curve
happens when a non price determinant of supply changes and the overall
relationship between price and quantity supplied is affected.

The standard trade model is a general model that includes the Ricardian
model, the Ronald ones and Paul Samuelson specific factors model, and
the Heckscher-Ohlin (H-O) model as special cases-two goods, food (F)
and cloth ©. Each country’s production possibility frontier (PPF) is a
Smooth curve.

The standard trade model assumes the following:

a. Each country produces two goods, food (F) and cloth ©.
b. Each country’s production possibility frontier (PPF) is a smooth
curve (TT).
c. The point on its PPF, at which an economy actually produces,
depends on the price of Cloth relative to food, PC/PF.
d. Isovalue lines are lines along which the market value of output is
constant.
A country’s production possibility frontier (PPF) determines its relative
supply function because it shows what the country is capable of
producing, which should be maximized. National relative supply
function determines the world relative supply function, which along with
world relative demand determines the equilibrium under international
trade.

The slope of an Isovalue line (relative price of cloth to food) equals

PC/PF. The best point to produce is where PPF is tangent to the isovalue
line, a line of slope equal to the relative prices.
The value of an economy’s consumption equals the value of its
production. The economy’s choice of a point on the isovalue line
depends on the tastes of its consumers, which can be represented
graphically by a series of indifference curves.

The standard trade model is built on four key relationships:

a. The relationship between PPF and the world relative supply (RS)
curve;
b. The relationship between relative prices (RP) and relative demand
(RD);
c. The world equilibrium as determined by world RS and RD; and
d. How changes in the terms of trade affect a nation’s welfare.

The world relative supply curve (RS) is upward slopping because an

increase in the price of cloth/price of food (PC/PF) leads both countries
to produce more cloth and less food.
The world relative demand curve (RD) is downward sloping because an
increase in PC/PF leads
Both countries to shift their consumption mix away from cloth toward
food.
Terms of trade (TOT) means the price of a country’s exports divided by
a country’s imports.
Generally, a rise in the TOT increases a country’s welfare, while a
decline in the TOT reduces its welfare. Intuitively, TOT falls, price of
what a country produces goes down relative to price of what the country
consumes. The relationship between TOT, total price of production, and
a country’s welfare is direct.