Category: Management Notes

1. Exporting

Exporting is the marketing and direct sale of domestically produced goods in another country. Exporting is a traditional and well-established method of reaching foreign markets. Since it does not require that the goods be produced in the target country, no investment in foreign production facilities is required. Most of the costs associated with exporting take the form of marketing expenses.

While relatively low risk, exporting entails substantial costs and limited control. Exporters typically have little control over the marketing and distribution of their products, face high transportation charges and possible tariffs, and must pay distributors for a variety of services. What is more, exporting does not give a company firsthand experience in staking out a competitive position abroad, and it makes it difficult to customize products and services to local tastes and preferences.

Exporting is a typically the easiest way to enter an international market, and therefore most firms begin their international expansion using this model of entry. Exporting is the sale of products and services in foreign countries that are sourced from the home country. The advantage of this mode of entry is that firms avoid the expense of establishing operations in the new country. Firms must, however, have a way to distribute and market their products in the new country, which they typically do through contractual agreements with a local company or distributor. When exporting, the firm must give thought to labeling, packaging, and pricing the offering appropriately for the market. In terms of marketing and promotion, the firm will need to let potential buyers know of its offerings, be it through advertising, trade shows, or a local sales force.

Among the disadvantages of exporting are the costs of transporting goods to the country, which can be high and can have a negative impact on the environment. In addition, some countries impose tariffs on incoming goods, which will impact the firm’s profits. In addition, firms that market and distribute products through a contractual agreement have less control over those operations and, naturally, must pay their distribution partner a fee for those services.

2. Licensing and Franchising

A company that wants to get into an international market quickly while taking only limited financial and legal risks might consider licensing agreements with foreign companies. An international licensing agreement allows a foreign company (the licensee) to sell the products of a producer (the licensor) or to use its intellectual property (such as patents, trademarks, copyrights) in exchange for royalty fees. Here’s how it works: You own a company in the United States that sells coffee-flavored popcorn. You’re sure that your product would be a big hit in Japan, but you don’t have the resources to set up a factory or sales office in that country. You can’t make the popcorn here and ship it to Japan because it would get stale. So you enter into a licensing agreement with a Japanese company that allows your licensee to manufacture coffee-flavored popcorn using your special process and to sell it in Japan under your brand name. In exchange, the Japanese licensee would pay you a royalty fee.

Licensing essentially permits a company in the target country to use the property of the licensor. Such property is usually intangible, such as trademarks, patents, and production techniques. The licensee pays a fee in exchange for the rights to use the intangible property and possibly for technical assistance as well.

Because little investment on the part of the licensor is required, licensing has the potential to provide a very large return on investment. However, because the licensee produces and markets the product, potential returns from manufacturing and marketing activities may be lost. Thus, licensing reduces cost and involves limited risk. However, it does not mitigate the substantial disadvantages associated with operating from a distance. As a rule, licensing strategies inhibit control and produce only moderate returns.

3. Contract Manufacturing and Outsourcing

Because of high domestic labor costs, many U.S. companies manufacture their products in countries where labor costs are lower. This arrangement is called international contract manufacturing or outsourcing. A U.S. company might contract with a local company in a foreign country to manufacture one of its products. It will, however, retain control of product design and development and put its own label on the finished product. Contract manufacturing is quite common in the U.S. apparel business, with most American brands being made in a number of Asian countries, including China, Vietnam, Indonesia, and India.

Thanks to twenty-first-century information technology, nonmanufacturing functions can also be outsourced to nations with lower labor costs. U.S. companies increasingly draw on a vast supply of relatively inexpensive skilled labor to perform various business services, such as software development, accounting, and claims processing. For years, American insurance companies have processed much of their claims-related paperwork in Ireland. With a large, well-educated population with English language skills, India has become a center for software development and customer-call centers for American companies.

4. Partnerships and Strategic Alliances

Another way to enter a new market is through a strategic alliance with a local partner. A strategic alliance involves a contractual agreement between two or more enterprises stipulating that the involved parties will cooperate in a certain way for a certain time to achieve a common purpose. To determine if the alliance approach is suitable for the firm, the firm must decide what value the partner could bring to the venture in terms of both tangible and intangible aspects. The advantages of partnering with a local firm are that the local firm likely understands the local culture, market, and ways of doing business better than an outside firm. Partners are especially valuable if they have a recognized, reputable brand name in the country or have existing relationships with customers that the firm might want to access. For example, Cisco formed a strategic alliance with Fujitsu to develop routers for Japan. In the alliance, Cisco decided to co-brand with the Fujitsu name so that it could leverage Fujitsu’s reputation in Japan for IT equipment and solutions while still retaining the Cisco name to benefit from Cisco’s global reputation for switches and routers. Similarly, Xerox launched signed strategic alliances to grow sales in emerging markets such as Central and Eastern Europe, India, and Brazil.

Strategic alliances and joint ventures have become increasingly popular in recent years. They allow companies to share the risks and resources required to enter international markets. And although returns also may have to be shared, they give a company a degree of flexibility not afforded by going it alone through direct investment.

There are several motivations for companies to consider a partnership as they expand globally, including (a) facilitating market entry, (b) risk and reward sharing, (c) technology sharing, (d) joint product development, and (e) conforming to government regulations. Other benefits include political connections and distribution channel access that may depend on relationships.

Such alliances often are favorable when (a) the partners’ strategic goals converge while their competitive goals diverge; (b) the partners’ size, market power, and resources are small compared to the industry leaders; and (c) partners are able to learn from one another while limiting access to their own proprietary skills.

What if a company wants to do business in a foreign country but lacks the expertise or resources? Or what if the target nation’s government doesn’t allow foreign companies to operate within its borders unless it has a local partner? In these cases, a firm might enter into a strategic alliance with a local company or even with the government itself. A strategic alliance is an agreement between two companies (or a company and a nation) to pool resources in order to achieve business goals that benefit both partners. For example, Viacom (a leading global media company) has a strategic alliance with Beijing Television to produce Chinese-language music and entertainment programming.

An alliance can serve a number of purposes:

• Enhancing marketing efforts
• Building sales and market share
• Improving products
• Reducing production and distribution costs
• Sharing technology

5. Acquisitions

An acquisition is a transaction in which a firm gains control of another firm by purchasing its stock, exchanging the stock for its own, or, in the case of a private firm, paying the owners a purchase price. In our increasingly flat world, cross-border acquisitions have risen dramatically. In recent years, cross-border acquisitions have made up over 60 percent of all acquisitions completed worldwide. Acquisitions are appealing because they give the company quick, established access to a new market. However, they are expensive, which in the past had put them out of reach as a strategy for companies in the undeveloped world to pursue. What has changed over the years is the strength of different currencies. The higher interest rates in developing nations has strengthened their currencies relative to the dollar or euro. If the acquiring firm is in a country with a strong currency, the acquisition is comparatively cheaper to make. As Wharton professor Lawrence G. Hrebiniak explains, “Mergers fail because people pay too much of a premium. If your currency is strong, you can get a bargain.

6. Foreign Direct Investment and Subsidiaries

Many of the approaches to global expansion that we’ve discussed so far allow companies to participate in international markets without investing in foreign plants and facilities. As markets expand, however, a firm might decide to enhance its competitive advantage by making a direct investment in operations conducted in another country.

Also known as foreign direct investment (FDI), acquisitions and greenfield start-ups involve the direct ownership of facilities in the target country and, therefore, the transfer of resources including capital, technology, and personnel. Direct ownership provides a high degree of control in the operations and the ability to better know the consumers and competitive environment. However, it requires a high level of resources and a high degree of commitment.

Multinational Corporations or Multinational Companies are corporate organizations that operate in more than one country other than home country. Multinational Companies (MNCs) have their central head office in the home country and secondary offices, facilities, factories, industries, and other such assets in other countries.

These companies operate worldwide and hence also known as global enterprises. The activities are controlled and operated by the parent company worldwide. Products and services of MNCs are sold around various countries which require global management.

Features of a Multinational Company (MNC)

1. High Turnover and Many Assets

MNCs operate on a global scale. Which means they have huge assets in almost all countries in which they operate. Their turnovers can also be incomprehensibly large. For example, Apple has a market capitalization of 1 trillion dollars. This is bigger than the entire economy of Saudi Arabia!

2. Control

MNCs have unity of control. So while they have many branches in many countries, the main control will remain with the head office in its country of origin. The business operations in the host country have their own management and offices, but the ultimate control will still remain at the head office.

3. Technological Advantages

As we saw earlier, an MNC has at its disposal huge amounts of wealth and investments. This allows them to use the best technology available to boost their products and their company. Most companies also invest huge money in their Research & Development Department to invent and discover new technological marvels.

4. Management by Professionals

An MNC is run by very competent and capable individuals. They have suitable managers to take care of their business operations, technology, finances, expansion etc. And they are also able to attract the top talent to their corporations due to their resources and their reputations.

5. Aggressive Marketing

MNCs can spend a lot of their money on marketing, advertising, and promotional activities. They target an international audience, so effective marketing becomes necessary. Aggressive marketing allows them to capture the market and sell their products globally.

Merits of MNCs

(i) Access to Consumers

Access to consumers is one of the primary advantages that the MNCs enjoy over companies with operations limited to smaller region. Increasing accessibility to wider geographical regions allows the MNCs to have a larger pool of potential customers and help them in expanding, growing at a faster pace as compared to others.

(ii) Accesses to Labor

MNCs enjoy access to cheap labor, which is a great advantage over other companies. A firm having operations spread across different geographical areas can have its production unit set up in countries with cheap labor. Some of the countries where cheap labor is available is China, India, Pakistan etc.

(iii) Taxes and Other Costs

Taxes are one of the areas where every MNC can take advantage. Many countries offer reduced taxes on exports and imports in order to increase their foreign exposure and international trade. Also countries impose lower excise and custom duty which results in high profit margin for MNCs. Thus taxes are one of the area of making money but it again depends on the country of operation.

(iv) Overall Development

The investment level, employment level, and income level of the country increases due to the operation of MNC’s. Level of industrial and economic development increases due to the growth of MNCs.

(v) Technology

The industry gets latest technology from foreign countries through MNCs which help them improve on their technological parameter.

(vi) R&D

MNCs help in improving the R&D for the economy.

(vii) Exports & Imports

MNC operations also help in improving the Balance of payment. This can be achieved by the increase in exports and decrease in the imports.

(viii) MNCs help in breaking protectionalism and also helps in curbing local monopolies, if at all it exists in the country.

Demerits of MNCs

(i) Laws

One of the major disadvantage is the strict and stringent laws applicable in the country. MNCs are subject to more laws and regulations than other companies. It is seen that certain countries do not allow companies to run its operations as it has been doing in other countries, which result in a conflict within the country and results in problems in the organization.

(ii) Intellectual Property

Multinational companies also face issues pertaining to the intellectual property that is not always applicable in case of purely domestic firms

(iii) Political Risks

As the operations of the MNCs is wide spread across national boundaries of several countries they may result in a threat to the economic and political sovereignty of host countries.

(iv) Loss to Local Businesses

MNCs products sometimes lead to the killing of the domestic company operations. The MNCs establishes their monopoly in the country where they operate thus killing the local businesses which exists in the country.

(v) Loss of Natural Resources

MNCs use natural resources of the home country in order to make huge profit which results in the depletion of the resources thus causing a loss of natural resources for the economy

(vi) Money flows

As MNCs operate in different countries a large sum of money flows to foreign countries as payment towards profit which results in less efficiency for the host country where the MNCs operations are based.

(vii) Transfer of capital

Transfer of capital takes place from the home country to the foreign ground which is unfavorable for the economy.

International business is defined as the transactions that are carried out across national borders to fulfill the objectives of individuals, companies and organizations. The different modes by which international business is being done are import-export trade, foreign direct investment, licensing, franchising and management contracts. Over the last five decades international trade and investment have grown faster than the domestic economies. International business facilitates flow of idea, services and capital across the globe.

International business is not a new phenomenon but has been practiced around the world for thousands of years. Through the routes established in the Mediterranean, the Phoenicians, Mesopotamians, and Greeks did trading. As sophisticated business techniques emerged, facilitating the flow of goods, resources and funds between countries flourished. This growth was further stimulated by colonization activities. The Industrial Revolution further stimulated the growth of international business by providing methods of production for mass ,markets and efficient methods for utilizing raw materials. The inventions and technological developments from Industrial revolution further accelerated the smooth flow of goods, services and capital between the countries. The production grew at unprecedented levels by 1880’s as the industrial revolution was in full swing in Europe and the United States. Growth continued in an upward spiral as mass production was realized and the manufactures were pushed to seek foreign markets for their products.

Factors leading to Growth in International Business

(i) Development and expansion of technology

The introduction of telegraph in 1837, the telephone in 1876, the wireless in 1895, the aero plane in 1903, the television in 1926, the liquid fuelled rocket in 1927, the coaxial cable in 1930’s and digital computer in 1946 were all the key events that triggered the growth of international business. Next to air transport, electronic communication, digital information processing has been the other principal area of technological innovation. All these technological advancements provided the platform for companies to set off increased number of international business activities.

(ii) Liberalization of cross border activities

The governmental barriers for international business have been lowered after the Second World War. The European Union, NAFTA, ASEAN and other regional economic blocs throughout the world provide fewer restrictions on cross border movements. The European Union was awarded the Nobel prize for peace 2012 in recognition for its constructive handling of peace, improving relations between nations through trade, reconciliation and human rights in Europe over the past six decades. The European commission president Jose Manuel Barrosa at the outset of receiving prize said that, “we honor this prize and will preserve what had been achieved. This achievement will propel the quest for shaping a better organized world with the values of freedom, democracy and human rights.”

Governments and companies have developed services that facilitate further international business. For instance Mail, which is a government monopoly, could be transferred by an airline other than that of the country of origin could go through many different countries before reaching the final destination with the stamp of the country of origin. Also banking institutions have developed effective and efficient means for companies to receive payment for their foreign sales. The banks can assist in the payment of any currency through various international transactions upon the receipt of goods /services.

International trade has a rich history starting with barter system being replaced by Mercantilism in the 16th and 17th Centuries. The 18th Century saw the shift towards liberalism. It was in this period that Adam Smith, the father of Economics wrote the famous book ‘The Wealth of Nations’ in 1776 where in he defined the importance of specialization in production and brought International trade under the said scope. David Ricardo developed the Comparative advantage principle, which stands true even today.

All these economic thoughts and principles have influenced the international trade policies of each country. Though in the last few centuries, countries have entered into several pacts to move towards free trade where the countries do not impose tariffs in terms of import duties and allow trading of goods and services to go on freely.

The 19th century beginning saw the move towards professionalism, which petered down by end of the century. Around 1913, the countries in the west say extensive move towards economic liberty where in quantitative restrictions were done away with and customs duties were reduced across countries. All currencies were freely convertible into Gold, which was the international monetary currency of exchange. Establishing business anywhere and finding employment was easy and one can say that trade was really free between countries around this period.

The First World War changed the entire course of the world trade and countries built walls around themselves with wartime controls. Post world war, as many as five years went into dismantling of the wartime measures and getting back trade to normalcy. But then the economic recession in 1920 changed the balance of world trade again and many countries saw change of fortunes due to fluctuation of their currencies and depreciation creating economic pressures on various Governments to adopt protective mechanisms by adopting to raise customs duties and tariffs.

The need to reduce the pressures of economic conditions and ease international trade between countries gave rise to the World Economic Conference in May 1927 organized by League of Nations where in the most important industrial countries participated and led to drawing up of Multilateral Trade Agreement. This was later followed with General Agreement of Tariffs and Trade (GATT) in 1947.

However once again depression struck in 1930s disrupting the economies in all countries leading to rise in import duties to be able to maintain favorable balance of payments and import quotas or quantity restrictions including import prohibitions and licensing.

Slowly the countries began to grow familiar to the fact that the old school of thoughts were no longer going to be practical and that they had to keep reviewing their international trade policies on continuous basis and this interns lead to all countries agreeing to be guided by the international organizations and trade agreements in terms of international trade.

Today the understanding of international trade and the factors influencing global trade is much better understood. The context of global markets have been guided by the understanding and theories developed by economists based on Natural resources available with various countries which give them the comparative advantage, Economies of Scale of large scale production, technology in terms of e commerce as well as product life cycle changes in tune with advancement of technology as well as the financial market structures.

For professionals who are occupying management or leadership positions in Organizations, understanding the background to the international trade and economic policies becomes necessary as it forms the backdrop for the business organizations to charter their course for growth.

Different nations all over the world are experiencing an essential change in the way they deliver and market various items, products and services. The national economies that were accomplishing the objective of self-sustainability are currently developing route towards International Business. The factor for this crucial change is the development of correspondence, innovation, communication, infrastructure and so on.

Introduction to Modern International Business

Business activities done across national borders is Modern International Business. The International business is the purchasing and selling of the goods, commodities and services outside its national borders. Such trade modes might be owned by the state or privately owned organization.

In which, the organization explores trade opportunities outside its domestic national borders to extend their own particular business activities, for example, manufacturing, mining, construction, agriculture, banking, insurance, health, education, transportation, communication and so on.

Nations that were away from each other, because of their geological separations and financial and social contrasts are now connecting with each other. World Trade Organization established by the administration of various nations is one of the major contributory factors to the expanded connections and the business relationship among the countries.

The national economies are dynamically getting borderless and fused into the world economy as it is clear that the world has today come to be known as a ‘global village’. Numerous more organization are making passage into a worldwide business which presents them with opportunities for development and tremendous benefits.

India was trading with different nations for quite a while, yet it has quickened its progress of incorporating with the world economy and expanding its foreign trade and investment.

With the globalization of the world economy, there has been a concomitant rise in the number of companies that operate globally. Though international business as a concept has been around since the time of the East India Company and continued into the early decades of the 20th century, there was a lull in the international expansion of companies because of the Two World Wars. After that, there was a hesitant move towards internationalizing the operations of multinational companies.

What really provided a fillip to the global expansion of companies was the Chicago School of Economic Thought propelled by the legendary economist, Milton Friedman, which championed neoliberal globalization. This ideology, which started in the early 1970s gradually, became a major force to reckon with in the 1980s and became the norm in the 1990s. The result of all this was the frenzied expansion of global companies across the world.

Thus, Modern international businesses grew in scope and size to the point where at the moment; the global economy is dominated by multinationals from all countries in the world. What was primarily a phenomenon of western corporations has now expanded to include companies from the East (from countries like India and China). This module examines the phenomenon of international businesses from different aspects like the characteristics of international business, their effect on the local, target economies, and the ways and means with which they would have to operate and succeed in the global competition for ideas and profits.

Above all, Modern international businesses have to ensure that they blend the global outlook and the local adaptation resulting in a “Global” phenomenon wherein they would have to think global and act local. Further, international businesses need to ensure that they do not fall afoul of local laws and at the same time repatriate profits back to their home countries. Apart from this, the questions of employability and employment conditions that dictate the operations of global businesses have to be taken into consideration as well.

Considering the fact that many third world countries are liberalizing and opening up their economies, there can be no better time than now for international businesses. This is balanced by the countervailing force of the ongoing economic crisis that has dealt a severe blow to the global economy. The third force that determines international businesses are that not only is the third world countries eager to welcome foreign investment, they seek to emulate the international businesses and become like them. Hence, these aspects would be discussed in detail in the subsequent articles.

Finally, Modern  international businesses have to ensure that they have a set of operating procedures and norms that are sensitive to the local culture and customs and at the same time, they stick to their brand that has been developed for global markets. This is the challenge that we discussed earlier as “Glocal” orientation.

In conclusion, Modern international businesses are facing the best of times and the worst of times at the same time and hence, the savvy and astute among them would succeed in this “Shift Age”.

Benefits of Modern International Business

International Business is important to both Nation and Business organizations. It offers them various benefits.

Benefits to Nation

• It encourages a nation to obtain foreign exchange that can be utilized to import merchandise from the global market.
• It prompts specialization of a country in the production of merchandise which it creates in the best and affordable way.
• Also, it helps a country in enhancing its development prospects and furthermore make opportunity for employment.
• International business makes it comfortable for individuals to utilise commodities and services produced in other nations which help in improving their standard of life.

Benefits to Firms

• It helps in improving profits of the organizations by selling products in the nations where costs are high.
• It helps the organization in utilizing their surplus resources and increasing profitability of their activities.
• Also, it helps firms in enhancing their development prospects.
• International business also goes as one of the methods for accomplishing development in the firms confronting extreme market conditions in the local market.
• And it enhances business vision as it makes firms more aggressive, and diversified.

Trade refers to the exchange of goods and services for money, which can be undertaken within the geographical limits of the countries or beyond the boundaries. The trade which takes place within the geographical boundaries of the country is called domestic business, whereas trade which occurs between two countries internationally, is called international business.

Entities engaged in international business often face more difficulties than the entities which conduct domestic business. Although international business enjoys large customer base as they operate in multiple countries. Here is an article which compiles the important differences between domestic and international business.

Domestic Business

The business transaction that occurs within the geographical limits of the country is known as domestic business. It is a business entity whose commercial activities are performed within a nation. Alternately known as internal business or sometimes as home trade. The producer and customers of the firm both reside in the country. In a domestic trade, the buyer and seller belong to the same country and so the trade agreement is based on the practices, laws and customs that are followed in the country.

There are many privileges which a domestic business enjoys like low transaction cost, less period between production and sale of goods, low transportation cost, encourages small-scale enterprises, etc.

Advantage of Domestic Business

(i) Simpler Market Analysis

Understanding each target market’s preferences poses a challenge when operating in international markets. Firms may need to invest substantial resources in analyzing what customers from other countries are most likely to purchase, and how to market to them. This may require a significant investment of time in each country, whereas in the domestic environment, a firm can often predict customer preferences more easily. It likely is more familiar with competitors’ offerings and can more easily understand its own market niche.

(ii) Communication is a Breeze

In the domestic business environment, communication is typically easier than in international environments. Employees in the domestic environment are typically from the same culture and speak the same language fluently, although exceptions do of course exist. Close communication must be maintained between operations in different nations, which requires significant time and effort.

(iii) Streamlined Reporting

A business typically has one set of requirements to follow regarding accountability in the domestic environment. Different sets of regulations may apply when a firm operates in international environments. The firm must then follow local environmental and labor regulations, the laws of its home country pertaining to international business, and any global regulations that apply. It must follow the relevant tax laws for each place of business. Overseeing the firm’s international operations requires time and effort. Thus, a domestic firm may have the advantage of spending relatively little on oversight in comparison to an international firm.

Disadvantage of Domestic Business

(i) Greater Impact from Cyclical Changes

Predicting cyclical changes usually tends to be easier in the domestic business environment. This allows a firm to prepare appropriately to take advantage of economic upturns and stay afloat during downturns. However, cyclical changes tend to affect a domestic firm more intensely than an international firm, making it more vulnerable to the ups and downs of the domestic market. A firm that does business in different countries has other ways of generating profit when domestic market conditions are poor, although it may have difficulty accurately predicting the cyclical changes in each country.

(ii) Limited Market Size

The size of the target market in a domestic environment can present a disadvantage, as the size may be limited. Nestlé branched out from Switzerland into other countries in part because of the extremely limited size of its target market in its home country. Businesses eager to expand may find themselves confronted with the challenge of branching out beyond their domestic borders. Extending into a larger environment can present far greater opportunities for generating a profit, particularly if a firm is willing to diversify its offerings.

(iii) Access to Materials and Labor

In a domestic environment, access to materials and labor may be limited. A firm with international operations might more easily and cheaply procure the raw materials or component parts of its products. Likewise, it might produce products more cost-effectively by creating them where labor is cheaper. A domestic firm might need to follow stricter regulations regarding employee wages. However, providing domestic jobs can lead to greater public goodwill for the company in its domestic environment.

International Business

International Business is one whose manufacturing and trade occur beyond the borders of the home country. All the economic activities indulged in cross-border transactions comes under international or external business. It includes all the commercial activities like sales, investment, logistics, etc., in which two or more countries are involved.

The company conducting international business is known as a multinational or transnational company. These companies enjoy a large customer base from different countries, and it does not have to depend on a single country for resources. Further, the international business expands the trade and investment amongst countries.

However, there are several drawbacks which act as a barrier to entry in the international market like tariffs and quota, political, socio-cultural, economic and other factors that affect the international business.

Advantages of International Business

The advantages of international business are as follows:

1. A Country can Consume those Goods which it cannot Produce

Commodities produced in India can be found in England and vice-versa. This helps England to enjoy those goods which he cannot produce in his country.

2. The Productive Resources of the World are Utilised to the Best Advantage of the Country

Every country expects highest return from its resources and this lead to fall in price and better goods for consumption.

3. Heavy Price Fluctuations are Controlled

If the price of any commodity goes up, the goods can be imported from abroad and its price can be brought down.

4. Shortages in Times of Famine and Scarcity can be met from Imports from Other Countries

Surplus produce can be sent out to needy countries. Food scarcity in India and Europe in often met by surplus food-grains from the U.S.A.

5. Countries Economically Backward but Rich in Resources may Develop their Industries

Indian people are opening industries with the idea of sending produced goods to foreign countries.

6. International Business Promotes Peace and Friendship

No country however big it may be can claim to be self-sufficient. It will have to depend on other country for something. Free international business is essential for goodwill, peace and to meet any requirements of the nation.

Disadvantages of International Business

The dis-advantages of international business are as follows:

1. The Worst Part of Foreign or International Business is the Destruction of Cottage and Home Industries

Indian industries need protection. If there will be no protection from the side of the government, Indian industries cannot prosper.

2. Dependence on Foreign Business Creates Difficulties in Times of Need

In the past, India had to face great trouble and difficulty in getting ordinary and simple articles like medicine and tools during need or during the war.

3. The Extreme Specialization which makes a Country Depend on One or Two Industries is Bad

Because if at any time the industry suffers the economic life of the people would be endangered.

4. Countries which Sell Raw Materials and Buy Manufactured Goods in Return are always Loser and cannot Improve the Country Economy

The standard of living of the people cannot improve. International business under such conditions leads more to discontent and unrest than to peace and goodwill.

5. International Business may Completely Exhaust a Country’s Natural Resources like Coal and Oil which are Irreplaceable

These goods are exported just for the sake of earning money and profit. But the country will have to suffer in the long run when their source will be dried up completely.

6. Imports of Harmful Drugs and Luxuries Goods ruin the Health of the Nation

For this people blame international business which is not correct.

7. International Business Rivalry Leads to Friction and War

Example of this kind it the last two world war. Commercial competition often brings strain relations between countries. Thus, it can be said that International Business is not unmixed blessing. But to measure advantages always outweigh the dis-advantages. At any rate, it is better if it is helpful in improving the economy of the country.

Comparison

	DOMESTIC BUSINESS	INTERNATIONAL BUSINESS
Meaning	A business is said to be domestic, when its economic transactions are conducted within the geographical boundaries of the country.	International business is one which is engaged in economic transaction with several countries in the world.
Area of operation	Within the country	Whole world
Quality standards	Quite low	Very high
Deals in	Single currency	Multiple currencies
Capital investment	Less	Huge
Restrictions	Few	Many
Nature of customers	Homogeneous	Heterogeneous
Business research	It can be conducted easily.	It is difficult to conduct research.
Mobility of factors of production	Free	Restricted

Differences between Domestic and International Business

The most important differences between domestic and international business are classified as under:

1. Domestic Business is defined as the business whose economic transaction is conducted within the geographical limits of the country. International Business refers to a business which is not restricted to a single country, i.e. a business which is engaged in the economic transaction with several countries in the world.
2. The area of operation of the domestic business is limited, which is the home country. On the other hand, the area of operation of an international business is vast, i.e. it serves many countries at the same time.
3. The quality standards of products and services provided by a domestic business is relatively low. Conversely, the quality standards of international business are very high which are set according to global standards.
4. Domestic business deals in the currency of the country in which it operates. On the contrary, the international business deals in the multiple currencies.
5. Domestic Business requires comparatively less capital investment as compared to international business.
6. Domestic Business has few restrictions, as it is subject to rules, law taxation of a single country. As against this, international business is subject to rules, law taxation, tariff and quotas of many countries and therefore, it has to face many restrictions which are barriers in the international business.
7. The nature of customers of a domestic business is more or less same. Unlike, international business wherein the nature of customers of every country it serves is different.
8. Business Research can be conducted easily, in domestic business. As against this, in the case of international research, it is difficult to conduct business research as it is expensive and research reliability varies from country to country.
9. In domestic business, factors of production are mobile whereas, in international business, the mobility of factors of production are restricted.

Carrying out the activities of international business and its management is far more difficult than conducting a domestic business. Due to changes in political, economic, socio-cultural environment across the nations, most business entities find it difficult to expand their business globally. To become a successful player in the international market firms need to plan their business strategies as per the requirement of the foreign market.

The North American Free Trade Agreement (NAFTA)

The North American Free Trade Agreement (NAFTA) is an agreement signed by the governments of Canada, Mexico, and the United States, creating a trilateral trade bloc in North America. The agreement came into force on January 1, 1994. It superseded the Canada – United States Free Trade Agreement between the U.S. and Canada.

In terms of combined GDP of its members, the trade bloc is the largest in the world as of 2010. NAFTA has two supplements: the North American Agreement on Environmental Cooperation (NAAEC) and the North American Agreement on Labor Cooperation (NAALC). The goal of NAFTA was to eliminate barriers to trade and investment among the U.S., Canada, and Mexico.

The implementation of NAFTA on January 1, 1994 brought the immediate elimination of tariffs on more than one-half of Mexico’s exports to the U.S. and more than one-third of U.S. exports to Mexico. Within 10 years of the implementation of the agreement, all U.S.–Mexico tariffs would be eliminated except for some U.S. agricultural exports to Mexico that were to be phased out within 15 years. Most U.S.–Canada trade was already duty free. NAFTA also seeks to eliminate non-tariff trade barriers and to protect the intellectual property rightof the products.

The agreement opened the door for open trade, ending tariffs on various goods and services, and implementing equality between Canada, America, and Mexico. NAFTA has allowed agricultural goods such as eggs, corn, and meats to be tariff-free. This allowed corporations to trade freely and import and export various goods on a North American scale.

South Asian Free Trade Area (SAFTA)

The South Asian Free Trade Area (SAFTA) is an agreement reached on January 6, 2004, at the 12th SAARC summit in Islamabad, Pakistan. It created a free trade area of 1.6 billion people in Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka to reduce customs duties of all traded goods to zero by the year 2016. The SAFTA agreement came into force on January 1, 2006, and is operational following the ratification of the agreement by the seven governments. SAFTA required the developing countries in South Asia (India, Pakistan and Sri Lanka) to bring their duties down to 20 percent in the first phase of the two-year period ending in 2007. In the final five-year phase ending in 2012, the 20 percent duty was reduced to zero in a series of annual cuts. The least developed nations in South Asia (Nepal, Bhutan, Bangladesh, Afghanistan and Maldives) had an additional three years to reduce tariffs to zero. India and Pakistan ratified the treaty in 2009, whereas Afghanistan as the 8th member state of the SAARC ratified the SAFTA protocol on 4 May 2011.

ASEAN

The ASEAN Free Trade Area (AFTA) is a trade bloc agreement by the Association of Southeast Asian Nations supporting local trade and manufacturing in all ASEAN countries, and facilitating economic integration with regional and international allies.[2][3][4] It stands as one of the largest and most important free trade areas (FTA) in the world, and together with its network of dialogue partners, drove some of the world’s largest multilateral forums and blocs, including Asia-Pacific Economic Cooperation, East Asia Summit and Regional Comprehensive Economic Partnership.

The AFTA agreement was signed on 28 January 1992 in Singapore. When the AFTA agreement was originally signed, ASEAN had six members, namely, Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand. Vietnam joined in 1995, Laos and Myanmar in 1997 and Cambodia in 1999. AFTA now comprises the ten countries of ASEAN. All the four latecomers were required to sign the AFTA agreement to join ASEAN, but were given longer time frames in which to meet AFTA’s tariff reduction obligations.

The primary goals of AFTA seek to:

• Increase ASEAN’s competitive edge as a production base in the world market through the elimination, within ASEAN, of tariffs and non-tariff barriers; and
• Attract more foreign direct investment to ASEAN.

South Asian Association for Regional Cooperation (SAARC)

The South Asian Association for Regional Cooperation (SAARC) is the regional intergovernmental organization and geopolitical union of states in South Asia. Its member states are Afghanistan, Bangladesh, Bhutan, India, the Maldives, Nepal, Pakistan and Sri Lanka. SAARC comprises 3% of the world’s area, 21% of the world’s population and 3.8% (US$2.9 trillion) of the global economy, as of 2015.

SAARC was founded in Dhaka on 8 December 1985. Its secretariat is based in Kathmandu, Nepal. The organization promotes development of economic and regional integration. It launched the South Asian Free Trade Area in 2006. SAARC maintains permanent diplomatic relations at the United Nations as an observer and has developed links with multilateral entities, including the European Union.

A greater part of economic theory has been formulated with the aid of the technique of economic statics.

However, during the last eighty years (since 1925) dynamic technique has been increasingly applied to the various fields of economic theory. J. M. Clark’s principle of acceleration and Aftalion theory of business fluctuations resulting from the lagged over-response of output to previous capital formation are some examples of dynamic models which appeared before 1925.

But prior to 1925, dynamic analysis was mainly confined, with some exceptions, to the explanation of business cycles. After 1925, dynamic analysis has been used extensively not only for the explanation of business fluctuations but also for income determination, growth and price theories. Economists like R. Frisch, C. F. Roos, J. Tinbergen, M. Kalecki, Paul Samuelson and many others have formulated dynamic models which give rise to cycles of varying periodicity and amplitude.

English writers such as Robertson, Keynes, Haberler, Kahn, and Swedish economists such as, Myrdal, Ohlin, Lindahl and Lunberg have laid a great stress on economic dynamics in the sphere of income analysis. More recently, economists like Samuelson, Goodwin, Smithies, Domar, Metzler, Haavelmo, Klein, Hicks, Lange, Koopmans and Tinter have further extended and developed dynamic models concerning the stability and fluctuations around any equilibrium point or path and which cover the four important fields of economic theory, namely, cycles, income determination, economic growth and price theory.

We shall explain below the meaning and nature of economic statics, dynamics and comparative statics and shall bring out the distinction between them. There has been a lot of controversy about their true meaning and nature, especially about economic dynamics.

Nature of Economic Statics:

The method of economic statics is very important since, as noted above, a large part of economic theory has been formulated with its aid. Besides, the conception of economic dynamics cannot be understood without being clear about the meaning of statics because one thing which is certain about economic dynamics is that it is ‘not statics’. J. R. Hicks aptly remarks, “The definition of Economic Dynamics must follow from the definition of Economic Statics; when we have defined one, we have defined the other.

In order to make the difference between the natures of economic statics and dynamics quite clear, it is essential to bring out the distinction between two sorts of phenomena, stationary and changing. An economic variable is said to be stationary, if the value of the variable does not change over time, that is, its value is constant over time. For instance, if the price of a good does not change as time passes, price will be called stationary.

Likewise, national income is stationary if its magnitude does not change through time. On the other hand, the variable is said to be changing (non-stationary) if its value does not remain constant through time. Thus, the whole economy can be said to be stationary (changing), if values of all important variables are constant through time (are subject to change).

It may be noted that the various economic variables whose behaviour over time is studied are prices of goods, quantity supplied, quantity demanded, national income, level of employment, the size of the population, the level of investment, etc.

It is worth mentioning that it is quite possible that whereas a variable may be changing from the micro point of view, but stationary from the macro point of view. Thus, the prices of individual goods may be changing, of which some may be rising and some falling, but the general price level may remain constant over time. Likewise, the national income of a country may be stationary while the incomes generated by various industries may be changing.

On the other hand, the particular variables may be stationary, while the economy as a whole may be changing. For example, even if the level of net investment in the economy is stationary, the economy as a whole may not be stationary. When there is a constant amount of net positive investment per annum, the economy will be growing (changing) since addition to its stock of capital will be occurring.

It should be carefully noted that there is no necessary relationship between stationary phenomenon and economic statics, and the changing phenomenon and dynamics. Although economic dynamics is inherently connected with only a changing phenomenon but the static analysis has been extensively applied to explain the changing phenomena.

The distinction between statics and dynamics is the difference between the two different techniques of analysis and not the two different sorts of phenomena. Prof. Tinbergen rightly remarks, “The distinction between Statics and Dynamics is not a distinction between two sorts of phenomena but a distinction between two sorts of theories, i.e., between two ways of thinking. The phenomena may be stationary or changing, the theory (the analysis) may be Static or Dynamic”

Static Analysis and Functional Relationships:

The test of economic theory is to explain the functional relationships between a system of economic variables. These relationships can be studied in two different ways. If the functional relationship is established between two variables whose values relate to the same point of time or to the same period of time, the analysis is said to be static. In other words, the static analysis or static theory is the study of static relationship between relevant variables.

A functional relationship between variables is said to be static if the values of the economic variables relate to the same point of time or to the same period of time. Numerous examples of static relationships between economic variables and the theories or laws based upon them can be given. Thus, in economics the quantity demanded of a good at a time is generally thought to be related to the price of the good at the same time.

Accordingly, the law of demand has been formulated to establish the functional relationship between the quantity demanded of a good and its price at a given moment of time. This law states that, other things remaining the same, the quantity demanded varies inversely with price at a given point of time. Similarly, the static relationship has been established between the quantity supplied and the price of goods, both variables relating to the same point of time. Therefore, the analysis of this price-supply relationship is also static.

Micro-Statics and Macro-Statics:

Generally, economists are Interested in the equilibrium values of the variables which are attained as a result of the adjustment of the given variables to each other. That is why economic theory has sometimes been called equilibrium analysis. Until recently, the whole price theory in which we explain the determination of equilibrium prices of products and factors in different market categories was mainly static analysis, because the values of the various variables, such as demand, supply, and price were taken to be relating to the same point or period of time.

Thus, according to this micro-static theory, equilibrium at a given moment of time under perfect competition is determined by the intersection of given demand and the supply functions (which relate the values of variables at the same point of time). Thus in Figure 4.1 given the demand function as demand curve DD and the supply function SS, the equilibrium price OP is determined.

The equilibrium amount supplied and demanded so determined is OM. This is a static analysis of price determination, for all the variables such as, quantity supplied, quantity demanded and the price refer to the same point or period of time. Moreover, the equilibrium price and quantity determined by their interaction also relate to the same time as the determining variables.

Examples of static analysis can also be given from macroeconomic theory. Keynesian macro model of the determination of level of national income is also mainly static. According to this model, national income is determined by the intersection of aggregate demand curve and aggregate supply curve (45° line) as is depicted in Figure 4.2 where the vertical axis measures consumption demand plus investment demand (C + l) and aggregate supply, and the X-axis measures the level of national income. Aggregate demand equals aggregate supply at point E and income OY is determined.

This is static analysis since aggregate demand (consumption and investment) and aggregate supply of output refer to the same point of time and element of time is not taken into account in considering the adjustment of the various variables in the system to each other. In other words, this analysis refers to instantaneous or timeless adjustment of the relevant variables and the determination of equilibrium level of national income.

Professor Schumpeter describes the meaning of static analysis as follows: “By static analysis we mean method of dealing with economic phenomena that tries to establish relations between elements of the economic system—prices and quantities of commodities all of which have the same time subscript, that is to say, refer to the same point of time. The ordinary theory of demand and supply in the market of an individual commodity as taught in every textbook will illustrate this case: it relates demand, supply and price as they are supposed to be at any moment of observation.”

Assumptions of Static Analysis:

A point worth mentioning about static analysis is that in it certain determining conditions and factors are assumed to remain constant at the point of time for which the relationship between the relevant economic variables and the outcome of their mutual adjustment is being explained. Thus, in the analysis of price determination under perfect competition described above, the factors such as incomes of the people, their tastes and preferences, the prices of the related goods which affect the demand for a given commodity are assumed to remain constant.

Similarly, the prices of the productive resources and production techniques which affect the cost of production and thereby the supply function are assumed to remain constant. These factors or variables do change with time and their changes bring about shift in the demand and supply functions and therefore affect prices.

But because in static analysis we are concerned with establishing the relationship between certain given variables and their adjustment to each other at a given point of time, changes in the other determining factors and conditions are ruled out. We, in economics, generally use the term data for the determining conditions or the values of the other determining factors. Thus, in static analysis, data are assumed to be constant and we find out the eventual consequence of the mutual adjustment of the given variables.

It should be noted that assuming the data to be constant is very much the same thing as considering them at a moment of time or in other words allowing them a very short period of time’ within which they cannot change. Moreover, the crucial point about static analysis is that the given conditions or data are supposed to be independent of the behaviour of variables or units in the given system between which functional relationship is being studied.

Thus, in the above static price analysis it is assumed that variables in the system, that is, price of the good, quantity supplied and quantity demanded do not influence the determining conditions or data of incomes of the people, their tastes and preferences, the prices of the related goods, etc. Thus, the relationship between the data and the behaviour of the economic variables in a given system is assumed to be one-way relationship; the data influence the variables of the given system and not the other way around.

On the contrary, we shall see below that in dynamic analysis the determinant data or determining conditions are not assumed to be constant. In dynamic analysis, certain elements in the data are not independent of the behaviour of the variables in a given system. In fact, in a fully dynamic system, it is hard to distinguish between data and variables since in a dynamic system over time “today’s determinant data are yesterday’s variables and today’s variables become tomorrow’s data. The successive situations are interconnected like the links of a chain.”

Since in static analysis, we study the behaviour of a system at a particular time, or in other words, in economic statics, we do not study the behaviour of a system over time. Therefore how the system has proceeded from a previous position of equilibrium to the one under consideration is not studied in economic statics. Prof. Stanley Bober rightly remarks.

“A static analysis concerns itself with the understanding of what determines an equilibrium position at any moment in time. It focuses attention on the outcome of economic adjustments and is not concerned with the path by which the system, be it the economy in the aggregate or a particular commodity market, has proceeded from a previous condition of equilibrium to the one under consideration.”

Relevance of Static Analysis:

Now, the question arises as to why the technique of static analysis is used which appears to be unrealistic in view of the fact that determining conditions or factors are never constant. Static techniques are used because it makes the otherwise complex phenomena simple and easier to handle. To establish an important causal relationship between certain variables, it becomes easier if we assume other forces and factors constant, not that they are inert but for the time it is helpful to ignore their activity.

According to Robert Dorfman, “Statics is much more important than dynamics, partly because it is the ultimate destination that counts in most human affairs, and partly because the ultimate equilibrium strongly influences the time paths that are taken to reach it, whereas the reverse influence is much weaker”.

To sum up, in static analysis we ignore the passage of time and seek to establish the causal relationship between certain variables relating to the same point of time, assuming some determining factors as remaining constant. To quote Samuelson who has made significant contributions to making clear the distinction between the methods of economic statics and dynamics, “Statics concerns itself with the simultaneous and instantaneous or timeless determination of economic variables by mutually interdependent relations.

Even a historically changing world may be treated statically, each of its changing positions being treated as successive states of static equilibrium.” In another article he says, ‘Statical then refers to the form and structure of the postulated laws determining the behaviour of the system. An equilibrium defined as the intersection of a pair of curves would be statical. Ordinarily, it is ‘timeless’ in that, nothing is specified concerning the duration of the process, but it may very well be defined as holding over time.”

Comparative Statics:

We have studied above static and dynamic analysis of the equilibrium position. To repeat, static analysis is concerned with explaining the determination of equilibrium values with a given set of data and the dynamic analysis explains how with a change in the data the system gradually grows out from one equilibrium position to another. Midway between the static and dynamic analyses is the comparative static analysis.

Comparative static analysis compares one equilibrium position with another when the data have changed and the system has finally reached another equilibrium position. It does not analyse the whole path as to how the system grows out from one equilibrium position to another when the data have changed; it merely explains and compares the initial equilibrium position with the final one reached after the system has adjusted to a change in data. Thus, in comparative static analysis, equilibrium positions corresponding to different sets of data are compared.

Professor Samuelson writes:

“It is the task of comparative statics to show the determination of the equilibrium values of given variables (unknowns) under postulated conditions (functional relationships) with various data (parameters) specified. Thus, in the simplest case of a partial equilibrium market for a single commodity the two independent relations of supply and demand, each drawn up with other prices and institutional data being taken as given determine by their interaction the equilibrium quantities of the unknown price and quantity sold.

If no more than this could be said, the economist would be truly vulnerable to that he is only a parrot, taught to say ‘supply and demand.’ Simply to know that there are efficacious ‘laws’ determining equilibrium tells us nothing of the character of these laws. In order for the analysis to be useful it must provide information concerning the way in which our equilibrium quantities will change as a result of changes in the parameters— taken as independent data”.

It should be noted that for better understanding of the changing system, comparative statics studies the effect on the equilibrium position of a change in only a single datum at a time rather than the effects of changes in the many or all variables constituting the data. By confining ourselves to the adjustment in the equilibrium position as a result of alteration in a single datum at a time, we keep our analysis simple, manageable and at the same time useful, instructive as well as adequate enough to understand the crucial aspects of the changing phenomena.

To quote Erich Schneider:

The set of data undergoes changes in the course of time, and each new set of data has a new equilibrium position corresponding to it. It is therefore of great interest to compare the different equilibrium positions corresponding to different sets of data. In order to understand the effect of a change in the set of data on the corresponding position of equilibrium, we must only alter a single datum at a time. Only in this way it is possible to understand fully the effects of alterations in the individual data.

We ask, to start with, about set I of the data, and the equilibrium position corresponding to it, then study next equilibrium position corresponding to set II of the data, where set II differs from set I only in the alteration of a single datum. In this way we compare the equilibrium values for the system corresponding to the two equilibrium positions with one another. This sort of comparative analysis of two equilibrium positions may be described as comparative-static analysis, since it studies the alteration in the equilibrium position corresponding to an alteration in a single datum”.

Let us give some examples of comparative static analysis from the microeconomic theory. We know that given the data regarding consumer’s tastes, incomes, prices of other goods on the one hand and the technological conditions, costs of machines and materials, and wages of labour we have given demand and supply functions which by their interaction determine the price of a good.

Now suppose that other things remaining constant, incomes of consumers increase. With the increase in incomes, the demand function would shift upward. With the change in the demand as a result of the change in the income, the supply would adjust itself and final new equilibrium position would be determined. To explain the determination of new equilibrium price and how it differs from the initial one is the task of comparative statics.

In Figure 4.3, initially the demand and supply functions are DD and SS and with their interaction price OP₁ is determined. When the demand function changes to D’D’ as a result of changes in consumers’ income, it intersects the given supply function at E₂ and the new equilibrium price OP₂ is determined.

In comparative-static analysis, we are concerned only with explaining the new equilibrium E₂ position comparing it with E₁, and not with the whole path the system has traversed as it gradually grows out from to E₂. As we shall study in the part of price theory, comparative static analysis was extensively used by Alfred Marshall in his time-period analysis of pricing under perfect competition.

Importance of Comparative Statics:

No doubt, more realistic, complete and true analysis of the changing phenomena of the real world would be the dynamic analysis nevertheless comparative statics is a very useful technique of explaining the changing phenomena and its crucial aspects without complicating the analysis.

To quote Schneider again. “This sort of dynamic analysis of the influence of a change in data is much more comprehensive and informative than the mere static analysis of two different sets of data and of the equilibrium positions corresponding to them. Nevertheless, the comparative static treatment provides some important insights into the mechanism of the exchange economy”.

Likewise, Professors Stonier and Hague write, “The construction of a truly dynamic theory of economics, where more continuous changes in demand and supply conditions, like those which occur in the real world, are analysed, is the ultimate goal of most theories of economics…. However, so far as the determination of price and output is concerned, simple comparative static analysis…. is as powerful an analytical method as we need”.

Economic Dynamics:

Now, we turn to the method of Economic Dynamics which has become very popular in modern economics. Economic dynamics is a more realistic method of analysing the behaviour of the economy or certain economic variables through time. The definition of economic dynamics has been a controversial issue and it has been interpreted in various different ways. We shall try to explain the standard definitions of economic dynamics.

The course thorough time of a system of economic variables can be explained in two ways. One is the method of economic statics described above, in which the relations between the relevant variables in a given system refer to the same point or period of time. On the other hand, if the analysis considers the relationship between relevant variables whose values belong to different points of time it is known as Dynamic Analysis or Economic Dynamics.

The relations between certain variables, the values of which refer to the different points or different periods of time, are known as dynamic relationships. Thus, J.A. Schumpeter says, “We call a relation dynamic if it connects economic quantities that refer to different points of time. Thus, if the quantity of a commodity that is offered at a point of time (t) is considered as dependent upon the price that prevailed at the point of time (t-l), this is a dynamic relation. In a word, economic dynamics is the analysis of dynamic relationships.

We thus see that in economic dynamics we duly recognize the element of time in the adjustment of the given variables to each other and accordingly analyse the relationships between given variables relating to different points of time.

Ragnar Frisch who is one of the pioneers in the use of the technique of dynamic analysis in economics defines economic dynamics as follows:

“A system is dynamical if its behaviour over time is determined by functional equations in which variables at different points of time are involved in a essential way. In dynamic analysis, he further elaborates, “We consider not only a set of magnitudes in a given point of time and study the interrelations between them, but we consider the magnitudes of certain variables in different points of time, and we introduce certain equations which embrace at the same time several of those magnitudes belonging to different instants. This is the essential characteristic of a dynamic theory. Only by a theory of this type we can explain how one situation grows out of the foregoing.

Many examples of dynamic relationships from both micro and macroeconomic fields can be given. If one assumes that the supply (S) for a good in the market in the given time (t) depends upon the price that prevails in the preceding period (that is, t – 1), the relationship between supply and price is said to be dynamic.

This dynamic functional relation can be written as:

S_t = f (P_t-1)

where S_t Stands for the supply of a good offered in a given period f and P_t-1for the price in the preceding period. Likewise, if we grant that the quantity demanded (D₁) of a good in a period Ms a function of the expected price in the succeeding period (t +1), the relation between demand and price will be said to be dynamic and the analysis of such relation would be called dynamic theory or economic dynamics.

Similarly, examples of dynamic relationship can be given from the macro field. If it is assumed that the consumption of the economy in a given period depends upon the income in the preceding period (t – 1), we shall be conceiving a dynamic relation.

This can be written as:

C_t = f (Y_t-1)

When macroeconomic theory (theory of income, employment and growth) is treated dynamically, that is, when macroeconomic dynamic relationships are analysed, the theory is known as “Macro dynamics”. Samuelson, Kalecki, Post-Keynesians like Harrod, Hicks have greatly dynamized the macroeconomic theory of Keynes.

Endogenous Changes and Dynamic Analysis:

It should be noted that the change or movement in a dynamic system is endogenous, that is, it goes on independently of the external changes in it; one change grows out of the other. There may be some initial external shock or change but in response to that initial external change, the dynamical system goes on moving independently of any fresh external changes, successive changes growing out of the previous situations.

In other words, the development of a dynamic process is self-generating. Thus, according to Paul Samuelson, It is important to note that each dynamic system generates its own behaviour over time either as an autonomous response to a set of ‘initial conditions’, or as a response to some changing external conditions. This feature of self-generating development over time is the crux of every dynamic process. Likewise, Professor J. K. Mehta remarks.

“In simple words, we can say that an economy can be said to be in a dynamical system when the various variables in it such as output, demand, prices have values at any time dependent on their values at some other time. If you know their values at one moment of time, you should be able to know their values at subsequent points of time. Prices of goods in a causal dynamic system do not depend on any outside exogenous forces. A dynamic system is self-contained and self-sustained”.

It is thus clear that a distinctive feature of dynamic analysis is to show how a dynamic process or system is self-generating, how one situation in it grows out of a previous one or how one situation moves on independently of the changes in external conditions. As Schneider, a German economist, has aptly and precisely put it, “A dynamic theory shows how in the course of time a condition of the economic system has grown out of its condition in the previous period of time. It is this form of analysis which has the central importance for the study of the process of economic developments, be they short-run or long-run processes.

An illustration of dynamic analysis may be given. level of national income is determined by the equilibrium between given aggregate demand curve and the aggregate supply curve. Now, if the aggregate demand increases, due to the increase in investment, the aggregate demand curve will shift upward and as a consequence the new equilibrium point will be reached and level of national income will rise.

In static analysis, the new equilibrium is supposed to occur instantaneously (timeless) and no attention is paid how the new equilibrium position of income has grown out of the original through time when the increase in aggregate demand has taken place.

That is to say, the dynamic analysis traces out the whole path through which the system passes over time to reach the new equilibrium position. We present in Figure 4.5 the common macro model of income determination. Given the aggregate demand C + 1, the level of national income OY₀ is determined y in time t. Suppose now the aggregate demand curve shifts upward due to the increase in investment in time period t.

As the investment increases in time-period t, the income will rise in time period t + 1 by the amount of the investment. Now, this increase in income will push up the consumption demand. To meet this increase in consumption, output will be increased with the result that income will further rise in period t + 2. This additional increase in income will induce further increase in consumption with the result that more output will be produced to meet the rise in demand and the income in period t + 3 will still further rise.

In this way, the income will go on rising; one increase in income giving rise to another till the final equilibrium point H is reached in the time period t + n in which the level of income OY_n is determined. The path by which the income increases through time is shown in the figure by dotted arrow lines. This illustration of macro-dynamics makes it clear that the dynamic analysis is concerned with how magnitude of variables in a period (income and consumption in the present illustration) depends upon the magnitudes of the variables in the previous periods.

Hicks’ Definition of Economic Dynamics:

In the light of our above explanation of the meaning of the method of economic dynamics, we are in a position to examine the definition of dynamics given by J. R. Hicks in his book ‘Value and Capital’. Hicks says, “I call Economic Statics those parts of economic theory where we do not trouble about dating. Economic Dynamics those parts where every quantity must be dated.

This is a very simple way of defining dynamics. When the magnitude of variables does not change with time, the dating of the quantities of variables is not necessary. In the absence of change in the economic variables determining the system, an equilibrium position that applies to the present will apply equally well to the future.

But in our view, this is not a satisfactory definition of economic dynamics. A system may be statical, but still may be dynamic according to Hicksian definition if some dates are attached to variables. Thus, a statical system may be converted into Hicksian dynamics by merely assigning some dates to the variables. But this is not true meaning of economic dynamics, as is now generally conceived. Mere dating of variables is not enough.

As has been made clear by Ragnar Frisch, variables in the system must relate to different dates or different points of time, if it is to be a truly dynamic system. Secondly, as has been contended by Paul Samuelson, this “Hicksian definition is too general and insufficiently precise. According to Paul Samuelson, Hicksian definition of dynamics would cover a historical static system of variables. An historically moving static system certainly requires dating of the variables but it would not thereby become dynamic.

A system of variables to be called dynamic must involve functional relationships between the variables, that is, the variables at one point of time must be shown to be dependent upon the variables at other points of time. Thus, according to Samuelson,” a system is dynamical if its behaviour over time is determined by functional equations in which variables at different points of time are involved in an essential way.

Thus, Samuelson’s emphasis is on functional relationships as well as on different points of time. We therefore conclude that a dynamical system involves functional relationships between variables at different points of time. A historically moving system does not necessarily involve the functional relationships between the variables at different historical times.

The historical movement of a system may not be dynamical. For instance, as has been pointed out by Samuelson, if one year crop is high because of good monsoons, the next year low because the monsoons fail, and so forth, the system will be statical even though not stationary.

The concept or technique of economic dynamics which we have explained above was first of all clarified by Ragnar Frisch in 1929. According to his view, like static analysis, economic dynamics is a particular method of explanation of economic phenomenon economic phenomena themselves may be stationary or changing. Although technique of dynamic analysis has great scope in a changing and a growing system but it may also be applied even to stationary phenomena.

A system or phenomenon may be stationary in the sense that the values of relevant economic variables in it may remain constant through time, but if the values of the variables at a time are dependent upon the values at another time, then dynamic analysis can be applied. But, as stated above, the greater scope of economic dynamics lies in the field of changing and growing phenomena. Schneider aptly brings out the distinction between statics and dynamics on the one hand and stationary and changing phenomena on the other when he writes.

It is essential to understand that in modern theory ‘statics’ and ‘dynamics’ refer to a particular mode of treatment or type of analysis of the phenomena observed, while the adjectives ‘stationary’ and ‘changing’ describe the actual economic phenomena. A static or dynamic theory is a particular kind of explanation of economic phenomena, and, indeed, stationary and changing phenomena can be submitted either to a static or to a dynamic analysis.

Expectations and Dynamics:

We have described abovethat economic dynamics is concerned with explaining dynamic relationships, that is, the relationships among variables relating to different points of time. The variables at the present moment may depend upon the variables at other times, past and future. Thus, when the relationship between the economic variables belonging to different points of time is considered, or when rates of change of certain variables in a growing economy are under discussion, the question of future creeps into the theoretical picture.

The economic units (such as consumers, producers and entrepreneurs) have to take decisions about their behaviour in the present period. The consumers have to decide what goods they should buy and what quantities of them. Similarly, producers have to decide what goods they should produce, what factors they should use and what techniques they should adopt.

These economic units decide about their present course of action on the basis of their expected values of the economic variables in the future. When their expectations are realised, they continue behaving in the same way and the dynamic system is in equilibrium. In other words, when the expectations of the economic units are fulfilled, they repeat the present pattern of behaviour and there exists what has been called dynamic equilibrium, unless some external shock or force disturbs the dynamic system.

The expectations or anticipations of the future held by the economic units play a vital role in economic dynamics. In a purely static theory expectations about the future have practically no part to play since static theory is mainly concerned with explaining the conditions of equilibrium positions at a point of time as well as under the assumptions of constant tastes, techniques and resources.

Thus, in static analysis expectations about the future play little part since under it no processes-aver time are considered. On the other hand, since dynamic analysis is concerned with dynamic processes over time, that is, changing variables over time and their action and interaction upon each other through time, expectations or anticipations held by the economic units about the future have an important place.

But from the intimate relation between dynamics and expectations it should not be understood that mere introduction of expectations in static analysis would make it dynamic. Whether the analysis is dynamic or not depends upon whether the relationship between variables belonging to different points or periods of time is considered or not, or whether rates of change of certain variables over time are considered or not. German economist Schneider rightly says, “A theory is not to be considered as dynamic simply because it introduces expectations, whether that is the case or not depends simply on whether or not the expected values of the single variables relate to different periods or points of time.”

Moreover, it is important to note that a theory becomes truly dynamic only if in it the expectations are taken as a variable and not as a given data. In other words, in a really dynamic theory, expectations should be considered as changing over time rather than remaining constant. A dynamic theory should tell us what would happen if, the expectations of the economic units are realised and what would happen if they have not come true.

In Harrod’s macro-dynamic model of a growing economy that if the entrepreneurs expect the rate of growth of output equal to s/C (whereas S stands for rate of saving and C for capital-output ratio) their expectations would be realised and as a result the relevant variables in the system will move in equilibrium over time and there will be a steady growth in the economy. If their expectations about the rate of growth are smaller or larger than s/C, they will not be realised and as a consequence there will be instability in the economy.

When the expectations of the individuals turn out to be incorrect, they will revise or change their expectations. Because of the changing nature of these expectations they should not be taken as given data or given conditions in a dynamic theory. To take expectations as given data means that they remain constant even if they turn out to be incorrect.

That is to say, even when the individuals are surprised by the actual events because their expectations have not been fulfilled, they will continue to have the same expectations. But that will amount to be assuming irrationality on the part of the individuals. We, therefore, conclude that expectations must be taken as changing in the dynamic system and not as a given condition.

Need and Significance of Economic Dynamics:

The use of dynamic analysis is essential if we want to make our theory realistic. In the real world, various key variables such as prices of goods, the output of goods, the income of the people, the investment and consumption are changing over time. Both Frischian and Harrodian dynamic analyses are required to explain these changing variables and to show how they act and react upon each other and what results flow from their action and interaction.

Many economic variables take time to make adjustment to the changes in other variables. In other words, there is a lag in the response of some variables to the changes in the other variables, which make it necessary that dynamic treatment be given to them. We have seen that changes in income in one period produce influence on consumption in a later period. Many similar examples can be given fpm micro and macro-economics.

Besides, it is known from the real world that the values of certain variables depend upon the rate of growth of other variables. For example, we have seen in Harrod’s dynamic model of a growing economy that investment depends upon expected rate of growth in output. Similarly, the demand for a good may depend upon the rate of change of prices.

Similar other examples can be given. In such cases where certain variables depend upon the rate of change in other variables, the application of both the period analysis and the rate of change analysis of dynamic economics become essential if we want to understand their true behaviour.

Until recently, dynamic analysis was mainly concerned with explaining business cycles, fluctuations or oscillations. But, after Harrod’s and Domar’s path-breaking contributions, the interest in the problems of growth has been revived among economists. It is in the study of growth that dynamic analysis becomes more necessary. Now-a-days economists are engaged in building dynamic models of optimum growth both for developed and developing countries of the world.

Thus, in recent years, the stress on dynamic analysis is more on explaining growth rather than cycles or oscillations. Prof. Hansen is right when he says, “In my own view mere oscillation represents a relatively unimportant part of economic dynamics. Growth, not oscillation, is the primary subject-matter for study in economic dynamics. Growth involves changes in technique and increases in population. Indeed that part of cycle literature (and cycle theories are a highly significant branch of dynamic economics) which is concerned merely with oscillation is rather sterile.