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Economics Master - Essay Example

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Economics Master

This theory explains why a firm will invest abroad, it is a classical theory developed by the work of Adam smith who stated that as firms grow and profits increase foreign direct investment enable the firm to shift surplus capital by investing elsewhere, the firm will also invest abroad due to increased competition in the home country and therefore decides to invest abroad where there is low competition.1
The work of Karl Marx also explains the existence of foreign direct investment, according to Marx as the rate of consumption in the home country decreases the profits of the firm declines and for this reason the firm will invest abroad for the reason of increasing consumption levels and profit levels.2
Therefore a firm according to this macro economic theory will invest abroad due to their abundance in capital and they will invest in the country which uses labour intensive means of production in order to increase profits as the cost of production is lower, the firm will find it more advantageous to invest in a country where labour cost are lower as the cost of labour in the home country is higher than the country abroad. ...
nvesting overseas, the firm which invest in other countries will experience economies of scale by investing in other countries which will be experienced due to the intangible assets that they possess, such intangible resources include skilled management and organisational know how which aid in experiencing the economies of scale when they invest abroad. The firms therefore will experience economies of scale in the market abroad due to their possession of technological know how whereby they will be in a position to reduce their cost of production.3

Location advantage theory:

This theory explains the product cycle which involves the production of new products using new technology and this products are first introduced to the home market, by investing abroad therefore the firm will be in a position to easily shift the production of this new products due to the nearness to the market abroad and also low cost of factors of production. This theory therefore concentrates on technological advantages that are experienced by a firm when they invest abroad.4

Internalisation theory:

The internalisation advantage theory gives the reason why firms will invest abroad rather than licence other foreign firms to undertake their production process, according to this theory when a firm licences another firm or even sub contracts a foreign firm to undertake production there arises transaction costs which may be greater than the costs that will be realised when the firm internalises its activities, it is cheaper for a firm to carry out its activities within the firm than to rely on other firms which it licences to undertake production. For this reason the firm will establish a subsidiary abroad.5

The eclectic theory;

The Eclectic theory which was developed by Dunning in 1970, this ...Show more


Foreign direct investment can be defined as the investments made by investors outside their own economy in order for them to earn interest on investment made, the two types of foreign direct investment (FDI) which are determined by the direction of investment include inward FDI and outward FDI, inward FDI takes place when foreign investment capital is invested in an economy whereas outward FDI takes place when local resources are invested in a foreign economy.
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Economics Master Essay essay example
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