International Marketing, 5th Edition

Trade is not a zero-sum game in the sense that one player (trading partner) can win only at the expense of another. Instead it is a positive-sum game because, for trade to take place, both nations must anticipate gain from it.

According to the principle of absolute advantage, a country should export a commodity that can be produced at a lower cost than can other nations. Conversely, it should import a commodity that can be only produced at a higher cost than can other nations.

The principle of relative advantage states that, although a country may be more efficient than another country in producing many products, it still should concentrate on either a product with the greatest comparative advantage or a product with the least comparative disadvantage. Conversely, it should import either a product for which it has the greatest comparative disadvantage or one for which it has the least comparative advantage.

Trade still should take place even when a country has an absolute advantage for all products over its trading partner as long as the degree of efficiency is not uniform across all products. As explained by the principle of relative advantage, absolute costs are irrelevant, and relative production costs instead should be used to determine whether trade will take place. A country should concentrate on either a product with the greatest comparative advantage or a product with the least comparative disadvantage.

Trade is unlikely when the domestic exchange ratio of one country is identical to that of another country. There is simply no incentive or gain from trading for either party. Also when transaction costs and transportation costs are considered, it becomes too expensive to export a product from one country to another.

The theory of factor endowment holds that the inequality of relative prices is a function of regional factor endowments and that comparative advantage is determined in part by the relative abundance of such endowments. Since countries have different factor endowments, a country would have a relative advantage in a commodity that embodies in some degree that country's comparatively abundant factors. A country should thus export that commodity which is relatively plentiful (i.e., in comparison to other commodities) within the relatively abundant factor (i.e., in comparison to other countries).

The Leontief Paradox casts some doubt on the validity of classical trade theories. Some empirical studies have shown that the export and import patterns of the United States are not consistent with the trade patterns as predicted by the theory of factor endowment. According to these studies, the United States actually exports labor-intensive goods and imports capital-intensive products (when the opposite results were expected).

Based on the empirical evidence and world trade patterns, the validity of trade theories is questionable and debatable as shown by the paradoxical findings. Apparently, other variables in addition to factor endowment affect trade practices. Trade theories fail to consider the demand side, marketing activities, and trade barriers. All of these can significantly alter trade patterns.

The value of the trade theories is limited by their assumptions: immobility and constancy of factors of production, homogeneous quality of factors of production, and fixed proportions of factor inputs for a product. In all fairness, certain simplifying assumptions are necessary, at least, in the early part of the investigation.

Free trade area: The countries involved eliminate duties among themselves, while maintaining separately their own tariffs against outsiders.

Customs union: Member countries must also agree on a common schedule of identical tariff rates against outsiders.

Common market: Countries remove all customs and other restrictions on the movement of the factors of production among the members of the common market.

Monetary union: Countries unify their currencies by either adopting a single currency or having convertible currencies with irrevocably fixed exchange rates.

Economic union: Countries harmonize their national economic policies so as to create a single market.

Political union: It involves both economic and political ties, and a treaty of integration between nations requires common economic and political policies.

Economic cooperation may either improve or impede international trade, depending on how the result of the cooperation is viewed. The tendency is for a member of an economic group to shift from the most efficient supplier in the world to the lowest-cost supplier within that particular economic region. As such, trade creation among the partners is offset by trade diversion from the rest of the world, and the net effect may be either positive or negative.