MGRECON401

Economics of International Business and Multinationals

LECTURE 2Global Sourcing Decisions

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The optimal sourcing and shipping decision of a multinational is similar to the optimal production and trade decision of the world’s resources.

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Lecture Focus

Explain the pattern of international trade observed in the world economy.

Understand the source of comparative and competitive advantage around the world.

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Unit Labor CostLabor Only Example

Production Technology Y = A*NY = OutputA = Labor ProductivityN = Labor

Production Cost = w*Nw = Wage Rate

Production Cost = w*N = w*(Y/A) = c*Yc = w/A = wN/Y = unit labor costc = marginal cost of production

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Unit Labor CostLabor Only Example

Profit = (p – c)Y

Lower Unit Labor Cost leads to higher profit per unit of production

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Unit Labor Cost

Definition: Unit Labor Cost = Wage divided by the marginal productivity of labor= w/MPL

Unit labor cost equals the cost required to produce one more unit of output with labor.

Inputs are at an optimal mix when the cost of producing one more unit of output with each input is equalized.

Unit labor cost = marginal cost of production.

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Unit Labor CostTechnical Appendix

Production Function (H1): Y = F(K,N)Cost Function: Cost = rK + wNUnit Labor Cost: ULC = w/FN(K,N)

Cost Minimization: FN(K,N)/w = FK(K,N)/r

Derivation: KFK(K,N)+ NFN(K,N) = (rK+wN)/ULC

Note for H1 functions: Y = KFK(K,N)+ NFN(K,N)

Derivation: Cost = ULC*Y = c*YProfit: (p-c)Y

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ComputingUnit Labor Cost

Value of output (sales) (Y) = payment to capital (rK) +payment to labor (wN) + payment for intermediate inputs (M).

Value-added (Y-M) =payment to capital (rK) +payment to labor (wN).

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ComputingUnit Labor Cost

Labor Productivity =Value-added per worker =(Y-M)/N

Unit labor cost (ULC) =Wage divided by labor productivity =wN/(Y-M)

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Unit Labor Cost and Competitive Advantage

A country has a competitive advantage in producing a good if it is the low cost producer of that good.

A country is a low cost producer of a good if wages are low relative to the productivity of producing that good.

Competitive advantage = low unit labor cost.

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Unit Labor Cost and Comparative AdvantageCountry A has a comparative advantage over Country B in producing Good X over Good Y if the productivity of Country A in producing Good X relative to the productivity of producing Good Y is higher than that ratio in Country B.

Countries specialize in the production of goods for which they have a comparative advantage.

Wage = marginal productivity of labor of goods that are produced (roughly, wage is determined by the marginal productivity of labor averaged over all goods)

Comparative advantage leads to specialization in the production of goods with low unit labor cost (other goods have a higher unit labor cost).

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Example ofComparative Advantage

Country A: Producing one less unit of Y saves up resources to produce two units of X.

Country B: Producing one less unit of Y saves up resources to produce one unit of X.

Country A has a comparative advantage in producing Good X.

If both countries produced X and Y, Country B could take one unit of Y, ship it to A, sell it for resources to produce two units of X, and ship two units of X back to Country B.

This trade works independent of how efficiently X and Y are produced with resources in either country.

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Unit Labor Cost in Japanese Manufacturing

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Obtaining Data onUnit Labor Cost

Groningen Growth and Development Center: International Comparisons of Output and Productivity by Industry:

http://www.ggdc.net/icop.html

Bureau of Labor and Statistics (BLS):http://www.bls.gov

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Theory of National Competitive Advantage

The theory attempts to analyze the reasons for a nation’s success in a particular industry

Porter studied 100 industries in 10 nations

Postulated that the determinants of competitive advantage of a nation were based on four major attributes

Factor endowmentsDemand conditionsRelated and supporting industriesFirm strategy, structure and rivalry

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Factor endowments

Factor endowments: A nation’s position in factors of production such as skilled labor or infrastructure necessary to compete in a given industry

Basic factor endowments

Advanced factor endowments

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Basic factor endowments

Basic factors: Factors present in a countryNatural resourcesClimateGeographic location

The

first

oil

well

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Advanced factor endowments

Advanced factors: the result of investment by people, companies, government.

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Advanced factor endowments

communicationsskilled laborresearchtechnologyeducation

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Demand conditions

Demand:

creates capabilities creates sophisticated and demanding consumers

Demand impacts quality and innovation

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Related and supporting industries

Creates clusters of supporting industries that are internationally competitive

Must also meet requirements of other parts of the Diamond

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Firm Strategy, Structure and Rivalry

Long term corporate vision is a determinant of success

Management ‘ideology’ and structure of the firm can either help or hurt you

Presence of domestic rivalry improves a company’s competitiveness

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Determinants of Competitive Advantage in nations

GovernmentGovernment

Company Strategy,Structure,

and Rivalry

DemandConditions

Relatedand Supporting

Industries

FactorConditions

ChanceChance

Two external factors that influence the four determinants.

Fig 4.8

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Caterpillar Tractor

What are key features of the EME industry?

What was CAT’s strategy that firmly established it as the #1 EME company? 

How well did CAT’s strategy fit with its organizational design and external environment? 

How is the EME industry changing? 

What are CAT’s vulnerabilities? Do you have any suggestions for how CAT should change?