Chapter 5

The Theory of Trade and Investment

True/False Questions

1. Modern telecommunications now takes labor to the place of business.

ANS: F PAGE: 150

2. International trade is expected to improve the productivity of industry and the

welfare of consumers.

ANS: T PAGE: 150

3. Feudal society was a state of mercantilism.

ANS: F PAGE: 150

4. As early as 1500 the benefits of trade were established in Europe.

ANS: T PAGE: 151

5. Autarky mixed exchange through trade with accumulation of wealth.

ANS: F PAGE: 150

6. The benefits of global trade have only really been felt over the last 100 years.

ANS: F PAGE: 150

7. Michael Porter is generally considered the father of economics.

ANS: F PAGE: 151

8. Adam Smith’s main areas of contribution were absolute advantage and the
division of labor.

ANS: T PAGE: 151

9. The production in one country of the same products as in others with fewer labor
hours is termed the Leontief Paradox.

ANS: F PAGE: 151

10. A limitation of Smith’s work was his failure to explain what gave rise to
production advantages.

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 ANS: T PAGE: 153

11. The notion that even if a country possesses absolute advantage in the production
of two products, it still must be relatively more efficient than the other country in
one good’s production than the other, is termed absolute advantage.

ANS: F PAGE: 153

12. Comparative advantage was based on what was given up or traded off in
producing one product instead of the other.

ANS: T PAGE: 153

13. Absolute advantage was based on what was given up or traded off in producing
one product instead of the other.

ANS: F PAGE: 154

14. What any given country can produce in isolation is referred to as Autarky.

ANS: T PAGE: 156

15. The trade-off of producing one product over another is termed opportunity cost.

ANS: T PAGE: 156

16. Production cost is the forgone value of a factor of production in its next-best use.

ANS: F PAGE: 156

17. Without trade, a country consumes what it produces.

ANS: T PAGE: 156

18. Heckscher and Ohlin explained how countries that seemingly had no obvious
reason for trade could specialize in producing what they did best and trade for
products they did not produce.

ANS: F PAGE: 159

19. The theory of comparative advantage argued that nations could improve the
welfare of their populations through international trade.

ANS: T PAGE: 159

20. The Hecksher-Ohlin theory considered two factors of production – labor and land.

ANS: F PAGE: 159

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21. Factor proportions theory assumes that labor and capital are mobile.

ANS: F PAGE: 160

22. Factor proportions theory assumes no productivity differences across nations.

ANS: T PAGE: 160

23. The factor proportions theory stated that a country should specialize in the
production and export of those products that use intensively its relatively
abundant factor.

ANS: T PAGE: 160

24. A country that is relatively labor poor should specialize in the production of
relatively labor-intensive goods.

ANS: F PAGE: 161

25. The increasing level of theoretical complexity of the factor proportions theory
decreased the number of assumptions necessary for the theory to “hold.”

ANS: F PAGE: 161

26. Input-output analysis is a technique of decomposing a good into the values and
quantities of the labor, capital, and other potential factors employed in the good’s
manufacture.

ANS: T PAGE: 162

27. The Leontief Paradox refers to the finding that U.S. firms exported more capital-
intensive products than were imported.

ANS: F PAGE: 162

28. Staffan Linder focused on the supply side.

ANS: F PAGE: 162

29. The overlapping product ranges theory would today be termed market segments.

ANS: T PAGE: 163

30. Linder’s work was instrumental in extending trade theory beyond cost
considerations, but failed to find a place in international marketing.

ANS: F PAGE: 163

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31. The stages of the product cycle are: the new product, the manufacturing stage, and
the standardized product.

ANS: F PAGE: 164

32. Raymond Vernon diverged from traditional approaches and focused on the
product.

ANS: T PAGE: 163

33. Throughout the product cycle, the countries of production, consumption, export,
and import are identified by their labor and capital levels.

ANS: T PAGE: 167

34. Product cycle theory was most important because it explained international
investment.

ANS: T PAGE: 167

35. Krugman examined the competitiveness of industries on a global basis.

ANS: F PAGE: 167

36. When the cost per unit of output depends on the size of an industry, not the size of
the individual firm, the industry of that country may produce at lower cost than
the same industry that is larger in size in the other countries.

ANS: F PAGE: 168

37. Porter characterized the dimensions of competition into four major components of
“the Leontif’s Paradox.”

ANS: F PAGE: 171

38. “Greenfield investment” refers to the purchase of an existing firm.

ANS: F PAGE: 174

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Multiple Choice Questions

1. The evolution of trade into the form we see today reflects ____________.

a. the collapse of the feudal society

b. the emergence of the autarky system in today’s world trade
c. the lifecycles of the colonial systems of the Asian countries
d. the lack of innovative economic theories explaining the benefits of trade
e. the work of Adam Smith only

ANS: a PAGE: 150

2. International trade is expected to

a. slow productivity of industry but improve the welfare of consumers.

b. improve productivity of industry and the welfare of consumers.
c. improve productivity of industry but not the welfare of consumers.
d. improve productivity of industry but reduce firm profitability.
e. improve the welfare of consumers but reduce profitability.

ANS: b PAGE: 150

3. Mercantilism

a. identified strength with the accumulation of gold and silver.

b. promoted imports.
c. limited exports.
d. emphasized a state of autarky.
e. was the foundation of the feudal system.

ANS: a PAGE: 151

4. The mercantilist philosophy involved all of the following EXCEPT

a. the accumulation of silver and gold.

b. the promotion of exports.
c. the promotion of imports.
d. the accumulation of specie.
e. one-way trade.

ANS: c PAGE: 151

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5. In the centuries leading up to the Industrial Revolution, international commerce
was largely conducted under the authority of

a. ruling religious officials.

b. feudal society.
c. large businesses.
d. monarchy.
e. governments.

ANS: e PAGE: 150

6. Feudal society was a state of ___________.

a. anarchy
b. monarchy
c. autarky
d. oligarchy
e. democracy

ANS: c PAGE: 150

7. ________ is considered the father of economics.

a. Wassily Leontief
b. Uncle Sam
c. Adam Smith
d. Milton Friedman
e. Einstein

ANS: c PAGE: 151

8. The Industrial Revolution_____________.

a. led to the creation of mercantilism

b. introduced the benefits of mass production
c. increased prices
d. lowered supplies of products
e. all of the above

ANS: b PAGE: 151

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9. Adam Smith’s main contributions were

a. production and absolute advantage.

b. division of labor and absolute advantage.
c. economies of scale and absolute advantage.
d. economies of labor and absolute advantage.
e. division of markets and absolute advantage.

ANS: b PAGE: 151

10. Absolute advantage refers to the

a. consumption advantage of one country over another.

b. productive advantage of one country over another.
c. export advantage of one country over another.
d. import advantage of one country over another.
e. none of the above.

ANS: b PAGE: 151

11. Dividing the production process into small segments or stages where exclusively
one individual performs each segment or stage is referred to as

a. the division of the production process.

b. the division skills.
c. the division of labor.
d. mass production.
e. none of the above.

ANS: c PAGE: 153

12. If the total labor-hours available for production within a nation were devoted to
the full production of one product, the ______ of the country could be
constructed.

a. point-factors
b. production possibilities frontiers
c. probability frontiers
d. production advantage
e. competitive advantage

ANS: b PAGE: 154

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13. According to David Ricardo, comparative advantage was based on

a. what was given up or traded off in producing one product instead of the
other.
b. what was gained in producing one product instead of the other.
c. what was gained in producing similar products.
d. what was given up or traded off in producing closely-related products.
e. what was gained by importing one product over another.

ANS: a PAGE: 154

14. ______ is the forgone value of a factor of production in its next-best use.

a. Autarky
b. Trade
c. Capital
d. Opportunity cost
e. Labor

ANS: d PAGE: 156

15. The trade-off of producing one product over the other is referred to as

a. trade-off alternatives.
b. opportunity costs.
c. opportunity benefits.
d. production costs.
e. production benefits.

ANS: b PAGE: 156

16. Classical trade theory ___________.

a. contributed much to the understanding of how production and trade operates

in the world economy
b. has been criticized for being unrealistic
c. simplifies reality
d. has been criticized for being out-of-date
e. all of the above

ANS: e PAGE: 159

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17. The Hecksher-Ohlin theory considered two factors of production, ________.

a. labor and land

b. land and capital
c. labor and capital
d. factors and labor
e. factors and capital

ANS: c PAGE: 159

18. The last step to understanding the benefits of ______ is to note that the point
where a country produces and the point where it consumes are now different.

a. modern trade
b. supply and demand
c. classical trade
d. opportunity costing
e. autarky system

ANS: c PAGE: 157

19. The theory of comparative advantage argued that nations could improve the
welfare of their populations through

a. increased population.
b. division of labor.
c. reduction of imports.
d. international trade.
e. specialized production.

ANS: d PAGE: 159

20. If product X requires one more unit of labor per unit of capital than product Y,
then __________.

a. product X is relatively labor intensive

b. product Y is absolutely labor intensive
c. product X is more competitive on world markets
d. labor should be shifted from producing product X to producing product Y
e. the theory of absolute advantage is proved

ANS: a PAGE: 159

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21. According to factor proportions theory, comparative advantage results from
__________.

a. technological differences
b. differences in labor skills
c. more open trade
d. relative differences in labor and capital endowments
e. all of the above

ANS: d PAGE: 159

22. Factor proportions theory stated that ___________.

a. a country should specialize in the production and export of those products that
use intensively its relatively abundant factor of production
b. a country should specialize in the production and import of those products that
use intensively its relatively abundant factor of production
c. a country should specialize in the production and export of those products that
use relatively little of its abundant factor of production
d. a country should specialize in the production and import of those products that
use relatively little of abundant factor of production
e. none of the above

ANS: a PAGE: 160

23. Leontief found that the products that U.S. firms exported were ________.

a. relatively more labor intensive than the products the U.S. imported
b. relatively more capital intensive than the products the U.S. imported
c. relatively more technology intensive than the products the U.S. imported
d. relatively more technology intensive than the products the U.S. exported
e. relatively more labor intensive than the products the U.S. exported

ANS: a PAGE: 162

24. Linder’s work focused on __________.

a. production
b. the supply side
c. preferences of consumers
d. the absolute advantage
e. the competitive advantage of nations

ANS: c PAGE: 162

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25. ______ is a technique of decomposing a good into the values and quantities of the
labor, capital, and other potential factors employed in the good’s manufacture.

a. Product Ranges Theory

b. Input-output analysis
c. Factor Proportion theory
d. Leontief Paradox
e. Product cycle theory

ANS: b PAGE: 162

26. Overlapping product ranges described by Linder would today be termed

a. overlapping cycles.
b. production overlap.
c. segments of division.
d. production segments.
e. market segments.

ANS: e PAGE: 163

27. Vernon developed the _____________.

a. product cycle theory

b. factor proportions theory
c. overlapping product ranges theory
d. absolute advantage theory
e. comparative advantage theory

ANS: a PAGE: 163

28. Vernon focused on __________.

a. the supply side

b. consumer preferences
c. production
d. demand efficiencies
e. the product

ANS: e PAGE: 163

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29. According to Linder, countries which trade intensively with one another normally

a. have very different skill and cost levels for labor.

b. are at very similar levels of economic development.
c. are presently military allies.
d. have shared in the development of new product technologies.
e. both belong to the WTO.

ANS: b PAGE: 163

30. Product cycle theory emphasizes that during the new product stage of the cycle

a. large quantities of unskilled labor are necessary.

b. countries f similar development levels will be major trading partners.
c. the production process is highly standardized.
d. profit margins on the new product are very high.
e. All of the above.

ANS: d PAGE: 164

31. Product cycle theory is

a. mainly supply-side in its orientation.

b. not focused on profit margins during the new product stage.
c. both supply-side and demand-side in its orientation.
d. heavily focused on profit margins during the new product stage.
e. skill-focused in its orientation.

ANS: c PAGE: 164

32. In the standardized product stage of the product life cycle, production takes place
_________.

a. in a foreign country
b. in the home country
c. in any industrialized nation
d. in any developing economy
e. wherever it is cheapest

ANS: e PAGE: 164

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33. The primary sources of discrepancy in statistics on international trade include
_______.

a. geographic coverage
b. partner-country attribution
c. non-filing of U.S. exports
d. low-value transactions
e. all of the above

ANS: e PAGE: 165

34. The Standardized Product Stage, the final stage of the product cycle, sees the
______ of production and export now shifting to the Less Developed Countries.

a. processes
b. comparative advantage
c. labor
d. competitive advantage
e. profit

ANS: b PAGE: 164

35. Although interesting in its own right for increasing emphasis on technology’s
impact on product costs, ______ was most important because it explained
international investment.

a. classical trade
b. Hecksher-Ohlin theory
c. factor proportions theory
d. product cycle theory
e. new trade theory

ANS: d PAGE: 167

36. When a country sees its own range of products in which its specialization become
narrow, it provides an opportunities for other countries to specialize in these so-
called

a. abandoned product ranges.

b. imperfect markets.
c. competitive product ranges.
d. comparative product markets.
e. perfect markets.

ANS: a PAGE: 168

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37. _______ examined the competitiveness of industries on a global basis, rather than
relying on country-specific factors to determine competitiveness.

a. Paul Krugman
b. Wasily Leontief
c. Michael Porter
d. Adam Smith
e. Ray Vernon

ANS: c PAGE: 167

38. Production of products that are ______ is termed product differentiation.

a. somewhat varied
b. extremely varied
c. similarly narrow and quite varied
d. differentiated
e. similarly narrow yet extremely similar

ANS: e PAGE: 168

39. Product cycle theory

a. recognizes the mobility of land across countries.

b. is least appropriate for technology-based products.
c. is least relevant to products that eventually fall victim to mass production.
d. served to breach a gap between trade theories of old and the intellectual.
challenges of a new, more globally competitive market.
e. All of the above.

ANS: d PAGE: 167

40. Internal economies of scale _________.

a. lead to imperfect markets

b. result in an industry maintaining its dominance in its field in world
markets
c. are similar to external economies of scale
d. involve intra-industry trade
e. all of the above

ANS: e PAGE: 168

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41. A firm possessing ________ economies of scale could potentially create
a(n)_________ market.

a. internal, imperfect
b. internal, perfect
c. external, imperfect
d. external, perfect
e. none of the above

ANS: a PAGE: 168

42. _________ trade occurs when a country seemingly imports and exports the same
product.

a. Intra-industry
b. Inter-industry
c. Cross industry
d. Bi-industry
e. Multi-industry

ANS: a PAGE: 168

43. External economies of scale may not necessarily lead to

a. internal markets.
b. imperfect markets.
c. perfect markets.
d. internal economies of scale.
e. relative markets.

ANS: b PAGE: 169

44. According to Porter, national prosperity __________.

a. is created
b. is inherited
c. grows out of a country’s natural endowments
d. grows out of a country’s labor pool
e. grows out of a country’s currency values

ANS: a PAGE: 171

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45. As trade theory evolved, it shifted its focus _________.

a. to the nation or country

b. to endowments or natural characteristics
c. to the industry and product level
d. to the national level competitiveness question
e. all of the above

ANS: c PAGE: 171

46. Porter argues that _________ drives and sustain competitiveness.

a. firm strategy
b. innovation
c. labor
d. management
e. markets

ANS: b PAGE: 171

47. The origins of trade theory hold that benefits accrue to those who successfully

a. consider both emotional and rational thought in decision-making.

b. entertain both the political and the economic.
c. consider current political welfare.
d. divorce the politic from the economic.
e. consider the political viewpoint.

ANS: d PAGE: 171

48. “The diamond of national advantage” includes _________.

a. the Leontif’s Paradox

b. the political stability of a nation
c. the socio-cultural dimension
d. firm strategy, structure, and rivalry
e. all of the above

ANS: d PAGE: 172

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49. Which of Porter’s four major components of “the diamond of national advantage”
is defined as the degree of health and competition on the firm must face in its
original home market?

a. Factor conditions
b. Demand conditions
c. Related and supporting industries
d. Firm strategy, structure, and rivalry
e. Supply conditions

ANS: b PAGE: 172

50. According to ________, no one managerial, ownership, or operational strategy is

universally appropriate.

a. Smith
b. Ricardo
c. Ohlin
d. Porter
e. Vernon

ANS: d PAGE: 172

51. It is a ______ and a ______ that are the subjects of trade.

a. country; buyer
b. country; market
c. firm; buyer
d. market; buyer
e. firm; country

ANS: c PAGE: 173

52. __________are “critical masses—in one place—of unusual competitive success

in particular fields.”

a. Group classes
b. Industry gatherings
c. Cluster events
d. Competitive gatherings
e. Competitive clusters

ANS: e PAGE: 173

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53. The movement of capital has allowed for ______ even though many of the
traditional trade theories assumed the immobility of the factors of production.

a. Bluefield investments
b. foreign direct investments
c. domestic investments
d. autarky systems
e. labor investments

ANS: b PAGE: 174

54. When a firm chooses to produce abroad it must make the conscious trade-off
between

a. cost versus control.

b. competitiveness versus control.
c. opportunities versus benefits.
d. profits versus joint ventures.
e. exporting versus importing.

ANS: a PAGE: 174

55. Greenfield investment refers to

a. investment by a firm in a Greenfield.

b. building a firm from the ground up.
c. the purchase of an existing firm.
d. agricultural investments abroad.
e. investment in a domestic firm which is too “green” for the international
market.

ANS: b PAGE: 174

56. Direct foreign investment can take place via _____.

a. exporting
b. importing
c. greenfield investments
d. bartering
e. all of the above

ANS: c PAGE: 174

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57. A joint venture is

a. a joint investment with another firm.

b. similar to a “Greenfield investment”.
c. an experiment with marijuana.
d. the best form of direct foreign investment.
e. None of the above.

ANS: a PAGE: 174

58. Firms may expand across borders in search of

a. resources.
b. factor advantages.
c. knowledge.
d. security.
e. All of the above.

ANS: e PAGE: 176

59. When firms acquire other firms for their technical or competitive skills, they are
seeking _________.

a. knowledge
b. markets
c. factor advantages
d. natural resources
e. training manuals

ANS: a PAGE: 176

60. When a country restricts imports of competitive products in order to allow

smaller, less competitive domestic firms to grow and prosper, it is called
_______.

a. tariffs
b. import enhancement law
c. non-tariffs
d. import substitution polices
e. none of the above

ANS: d PAGE: 177

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61. Which of the following problems is not avoided by producing in other countries?

a. Avoiding import tariffs

b. Gaining access to low cost labor
c. Gaining access to raw materials
d. Gaining technological advantages by producing within richer countries
e. a and b

ANS: d PAGE: 176

62. Which of the following is considered to be a market imperfection that covers the
entire range of supply and demand of the market?

a. Tax policies and innovations

b. Preferential trading agreements established by firm themselves
c. Tariffs and quotas
d. Purchasing policy
e. Financial restrictions on the access of domestic firms to foreign capital
markets

ANS: c PAGE: 177

63. The theory that explains why firms conduct most of the stages of production and
marketing themselves rather than licensing some parts out or use management
contracts is known as __________.

a. internalization
b. internationalization
c. the diamond of competitive advantage
d. absolute advantage
e. comparative advantage

ANS: a PAGE: 177

Short Answer Questions

1. Discuss the differences between the theory of comparative advantage and the
theory of absolute advantage.

ANS: Absolute Advantage is the ability of a country to produce a product with

fewer inputs than another country. It is possible to have an absolute advantage in
the production of more than one product. Comparative advantage is the notion
that although a country may produce both products more cheaply than another
country, it is relatively better at producing one product than the other.

PAGE: 151-153

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2. Discuss the concept of a feudal society, and the reasoning behind its evolutionary
collapse.

ANS: Feudal society was a state of autarky, a society that did not trade because of
all of its needs were met internally. The feudal estate was self-sufficient,
although hardly “sufficient” in more modern terms, given the limits of providing
entirely for oneself.

PAGE: 150

3. Address the effects of classical trade and comparative advantage in regard to

society.

ANS: Society’s welfare, which is normally measured in its ability to consume

goods or services is increased through trade. The theory of comparative
advantage argued that nations could improve the welfare of their populations
through international trade.

PAGE: 157-159

4. According to the theory of factor proportions, what is the source of comparative

advantage?

ANS: The source of comparative advantage according to factor proportions theory

is the elative abundance of whichever factor of production is needed most
intensively in the production process. According to the theory, comparative
advantage does not arise from technological advantage because it is assumed that
all countries have access to the same technology.

PAGE: 160

5. Discuss Leontief’s work.

ANS: In an effort to explain the types of goods the U.S. traded, Leontief tested
factor proportions theory. Using a method known as input-output analysis to
determine the relative amounts of labor, capital, and other potential factors
employed in the manufacturing of products, Leontief found that the U.S. exported
labor-intensive products and imported capital-intensive products. His findings
were controversial because they were exactly opposite of what was generally
believed to be true.

PAGE: 161-162

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6. Discuss Linder’s work, and its importance to the field of marketing.

ANS: Linder developed the overlapping product ranges theory. According to the
theory, trade in manufactured goods was dictated not by cost concerns, but by the
similarity in product demands across countries. So, his work focused not on the
production or supply side, but on the preferences of consumers—the demand side.
The overlapping product ranges described by Linder are today termed market
segments.

PAGE: 162-163

7. According to the product cycle theory, what is the source of comparative

advantage?

ANS: The source of comparative advantage according to the product cycle theory
is the ability to use large quantities of capital in combination with abundant highly
skilled labor in order to conduct high levels of research and development. As the
resulting product and its production mature over time, the location of comparative
advantage eventually shifts to the country with the lowest cost sources of
unskilled labor.

PAGE: 163

8. Discuss Raymond Vernon’s technology-based additions to the traditional

approaches.

ANS: Technical innovations leading to new and profitable products require large
quantities of capital and highly skilled labor. Both the product itself and the
methods for its manufacture go through three stages of maturation as the product
becomes increasingly commercialized. As the manufacturing process becomes
more standardized and low-skill labor-intensive, the comparative advantage in its
production and export shifts across countries.

PAGE: 163-164

9. Discuss cost of production as associated with The New Product Stage of Product
Cycle Theory.

ANS: Costs of production in this stage are quite high. The innovator at this stage
is a monopolist and therefore enjoys all of the benefits of monopoly power,
including the high profit margins required to repay the high development costs
and expensive production process.

PAGE: 164

10. According to Michael Porter, what is the source of comparative advantage?

ANS: Porter’s theory of the competitive advantage of nations suggests the source
of comparative advantage lies in the combined effect of four different factors: (1)

5-22
 factor conditions, (2) demand conditions, (3) related and supporting industries,
and (4) firms strategy, structure, and rivalry. Porter emphasizes that it is the
unique combining of these factors that allow some firms to be competitive in
industries and countries which would ordinarily not be explained by either factor
proportions theory or product cycle theory.

PAGE: 171-172

11. Explain why international investment may be a good alternative to international

trade.

ANS: Investing and producing in a foreign country allows a firm to avoid tariffs
that may be imposed on imports. Foreign production also allows a firm to have
close access to natural resources that are important to the product it produces.
Finally, foreign production gives a firm access to cheaper factors of production,
allowing the firm to increase its overall efficiency and competitiveness.

PAGE: 173-174

12. What lies at the heart of the process of international investment?

ANS: Capital mobility. Although labor is generally immobile, it is the ability of

capital to move to the location of sources of competitive advantage, which allows
international investment to take place.

PAGE: 174

13. Discuss the direct foreign investment decision sequence.

ANS: A firm must initially decide whether to exploit its existing competitive
advantage abroad, or develop a new competitive advantage in the domestic
market. Then, a firm must identify the production location. Next, control issues
and the form of investment must be addressed.

PAGE: 174-175

14. Discuss the trade-off confronted by all firms wishing to pursue direct foreign
investment.

ANS: A firm wishing to produce abroad must consider the spectrum of

alternatives available to it. The lowest cost alternatives require the firm to work
with together with other firms in that country. These cooperative structures,
which include licensing, joint ventures, and management contracts, require the
firm to give up varying levels of control, and potentially give up the technological
advantage that may lie at the heart of its competitive advantage. However, if the
firm wishes to maintain full rights and control, it must also assume the full cost of
foreign investment and production.

PAGE: 174-175

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15. Discuss what a firm may be seeking when it invests abroad.

ANS: A firm investing abroad may be seeking resources, factor advantages,

knowledge, security, or markets.

PAGE: 176

16. Explain internalization theory.

ANS: A firm, by establishing its own multinational operations, can internalize

production, effectively keeping confidential the information that is at the core of
its competitiveness.

PAGE: 177

Essay Questions

1. Discuss the product cycle theory. What are the trade implications of the product
cycle?

ANS: See the discussion under the “stages of the product cycle.”

PAGE: 164

2. What led to the development of new trade theory?

ANS: In the 1980s and 1990s, global trade developments led to much criticism of
the existing theories of trade. First, although there was rapid growth in trade,
much of it was not explained by current theory. Second, the massive size of the
merchandise trade deficit of the U.S. and the associated decline of many U.S.
firms in terms of international competitiveness sparked interest in seeking a new
explanation. Krugman’s theory emphasizing internal and external economies of
scale, and Porter’s diamond of national advantage were regarded as potential
ways to increase the understanding of the new trading environment.

PAGE: 167

3. Discuss the different components of Porter’s “diamond of national advantage.”

ANS: See the discussion under “the competitive advantage of nations.”

PAGE: 171-172

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4. Compare and contrast the Greenfield investment vs. purchasing an existing firm.

ANS: A Greenfield investment is the most expensive of all foreign investment

alternatives. The acquisition of an existing firm is often lower in initial cost but
may also contain a number of customizing and adjustment costs that are not
apparent at the initial purchase. The purchase of a going concern may also have
substantial benefits if the existing business possesses substantial customer and
supplier relationships that can be used by the new owner in the pursuit of its own
business.

PAGE: 174-175

5. Mention and discuss the sources of profit or opportunity that may encourage a
firm to expand across borders.

ANS: A firm may be seeking unique and valuable natural resources for their
products. They may also be seeking factor advantages. Resources needed for
production are often combined with other advantages that are inherent in the
country of production. The firm may be seeking knowledge in the form of
technical or competitive skills, or security which may include political stability.
Finally, firms are seeking the ability to gain and maintain access to markets .

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