Page 108 - Business Principles and Management

Chapter 4 • International Environment of Business

4.3 Theories of International Trade Investment

Goals Terms
• Explain two theories of • comparative • balance of payments
international trade. advantage theory • current account
• Discuss the concepts of balance • product life cycle • capital account
of trade and balance of payments. theory
• Consider career opportunities in
international business and under-
stand the factors related to being
sent abroad on assignment.

Theories of International Trade

In this section, you will learn about two well-known theories that explain why
international trade and investment occur.

COMPARATIVE ADVANTAGE THEORY
The comparative advantage theory states that to gain a trade advantage, a coun-
try should specialize in products or services that it can provide more efficiently
than can other countries. For instance, because of climate and soil conditions,
Brazil is better able to grow coffee than India, whose soil and climate favor the
growing of tea. Each country could gain by specializing—Brazil in coffee and
India in tea—and then trading with each other.
What if one country can produce both coffee and tea at a lower cost than
another country? The comparative advantage theory says that the focus should
be on comparing the cost of producing both products in each country. For
example, it is possible that India may be able to produce more tea than coffee
for the same cost, whereas Brazil may find that it can produce coffee at a
lower cost than it can produce wine. In such a case, Brazilians should special-
ize in producing and selling coffee to the Indians and buying tea from India.
Similarly, the Indians should produce tea and sell some to the Brazilians to
pay for the coffee they need. This theory explains why the United States pro-
duces computers, Saudi Arabia extracts oil from the earth, and Indonesia makes
athletic shoes.

PRODUCT LIFE CYCLE THEORY

The product life cycle theory provides another explanation for trade and invest-
ment. In a later chapter, you will learn that a product or service goes through
four stages: introduction, growth, maturity, and decline. Consider black-and-
white televisions, for example. When they were first introduced in the 1940s
and 1950s, they were the only televisions available. As more people in the country
started buying TVs, their sales grew—the growth stage. When most households

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