International Economics

TOPIC 4
Modern Trade Theories: mainstreams and comments
This topic covers : R.C: chapter 4 P.K:chapter5,6 M.K: chapter 7,8

Topic 4 Outline
Economies of Scale in Imperfect Competition Market Effects of a Larger Market Intra-industry Trade Economic analysis on Dumping Topic Story: Fairness Trade

2013/4/12

Classical Mainstream
Difference in factor cost, price and product price is the main source of the specification and trade opportunities and gains; Industries and nations will follow their advantages to trade with each other External elements assumed not to act in the trade world
2013/4/12 3

New Trend in Modern Trade Theory

Trade pattern is mainly explained by homogeneous factors rather than heterogeneous factors (Leontiefs Paradox in 1950s) Trade takes place between like-products in DCs Dynamic advantage formation in LDCs External factor shapes the trade competitiveness of an industry or a country
2013/4/12 4

Comments
Theoretical development in line with: FACTORS MARKET STRUCTURE FEATURES OF INDUSRIES BUSINESS CYCLES TRADE FAIRNESS
2013/4/12 5

1. Economies of Scale
A decrease in the unit cost of a product or a service owing to larger scale production.This may result from:
Volume purchase at a lower price; More efficient machinery; Sizable generation of by-products; Greater bargaining power; Simply, Indivisibility

(Joseph A. Schumpeter: Lumpage)

2013/4/12 6

Types of Economies of Scale

External Economies of Scale: a change of unit cost resulting from the size of industry (industrywide). Internal Economies of Scale: a change of unit cost resulting from individual firm operation. Diseconomies of Scale: the larger it grows, the less efficient the management and the higher the average cost.
2013/4/12 7

Why the trade world considered

The production is more efficient ,the larger the scale at which it takes place.
Now, Review the Recardian model: Cheese Wine
Home Foreign 1 3 hour per p 2 p 6
8

hour pre

2013/4/12

A very important Assumption

For any extra unit of Cheese in the home country and wine in the foreign country, the labor input remains unchanged, that is, the input/out ratio for cheese would permanently be 1, and 3 for wine.

2013/4/12

The case in the real world

Output Input 5 10 20 30
2013/4/12

Total input 10 15 25 35

Average

2
1.5 1.25 1.167
10

Graphically, this shows a decline curve of AC

Cost

AC Quantity
2013/4/12 11

Trade takes place when

(H,F)Producers are taking advantage of economies of scale without additional input above others; (H,F)Consumers enjoy a variety of goods or services due to larger production of limited things from specialized economies.
2013/4/12 12

The simple conclusion is

Economies of Scale can create a comparative advantage for an industry or a country other than labor (or factor) cost saving. This acts as new basis for trade But this must be considered with a market structure.
2013/4/12 13

Monopolistic profit as an advantage: pw AC E F

p,c pw
AC E F

AC D Q
14

MC MR
2013/4/12

Market Structure: imperfect vs. perfect

Pure monopoly: unique supplier or demander in the market. Oligopoly: several firms with large enough power on pricing but none with uncontested monopoly. Perfect competition: firms in the market with complete freedom of entry and withdraw, no special advantages of any seller or buyer over another.
2013/4/12 15

Imperfect Competition
is more realistic. Is a more relevant market structure for understanding economies of scale. may be distorted both by collusive and strategic behavior in form of either lower pricing or higher pricing collusion

2013/4/12

16

Monopoly and Trade

Effect of A Larger Market: p,c cc1
P1 P2 E2 PP CC2

As sales rise in a larger market

Price/firms N Enter Number

17

n1
2013/4/12

n2

Why there is a price reduction

CC curve is upward sloping because as the number of entering firms increases, the average cost tends to go up. Market then finds its equilibrium point at E2. price declines, more consuming goods will be created in a larger and integrated market
2013/4/12 18

Trade possibility: the general case

Consumers: Prefer to be a part of larger market as a greater variety of goods is available at lower prices. Therefore, Given the same level of factor endowment, trade will go to advantageous nations with Economy of Scale
2013/4/12

Producers: Small sized producers will be phased out as they are not able to bear the narrowed profit margin.

19

Imperfect competition and Intraindustry Trade

Interindustry Trade Home K goods L goods Intraindustry Home K goods L goods

K goods

L goods

K goods

L goods

No EconomyForeign of Scale
2013/4/12

In Case of Economy of Scale

Foreign

20

How intra-industry trade matters

From the viewpoint of H-O theorem, the comparative advantages in supply side do not exist in same industries, but It really matters for those countries who have similar capital-labor ratio as the trade taking place between advanced industrial countries is mostly understood in this way. 2013/4/12 21

Why Intraindustry Trade Occurs

the share of IIT in total international trade is growing all the time, at about 4-5% a year Products are highly differentiated within one item of SITC. Finger (1975), occurrence of intra-industry trade was unremarkable as existing classifications place goods of heterogeneous factor endowments in a single industry. However, evidence shows that even when industries are disaggregated to extremely fine levels IIT still occurs. Overlapping demand structure. More gains than in interindustry trade. 2013/4/12

22

Paul Krugman: New Trade Theory

Krugman: economies specialise to take advantage of increasing returns, not following differences in regional endowments In particular, trade allows countries to specialise in a limited variety of production and thus reap the advantages of increasing returns (ie, economies of scale), but without reducing the variety of goods available for consumption.
2013/4/12 23

How measure IIT

difficult to measure statistically because regarding products or industries as "the same" is partly a matter of definition and classification: Examples: Moto cars like a BMW and a Ford Beer like a Budweiser and a Heineken they are really all different products!
2013/4/12 24

IIT Index
Various indexes of IIT have been created.These include: the Grubel-Lloyd Index the Balassa index, the Aquino index, the Bergstrand index and the Glesjer index
2013/4/12 25

Fair Trade: (no universally accepted definition )

is an organized social movement and marketbased approach that aims to help producers in developing countries and promote sustainability. The movement advocates the payment of a higher price to producers as well as social and environmental standards. It focuses in particular on exports from developing countries to developed countries, most notably handicrafts, coffee, cocoa, sugar, tea, bananas, honey, cotton, wine, fresh fruit, chocolate and flowers. Fair Trade's strategic intent is to work with marginalized producers and workers in order to help them move towards economic selfsufficiency and stability. It also aims to allow them to become greater stakeholders in their 26 2013/4/12

Fairness in trade
is a trading partnership, based on dialogue, transparency and respect, that seeks greater equity in international trade. It contributes to sustainable development by offering better trading conditions to, and securing the rights of, marginalized producers and workers especially in the South. Fair Trade Organizations, backed by consumers, are engaged actively in supporting producers, awareness raising and in campaigning for changes in the rules and practice of conventional international trade

2013/4/12

27

Further Reading Suggestion

Grimwade, International Trade: New Patterns of Trade, Production & Investment, second edition 2000, p. 71 ^ Krugman & Obstfeld (1991) ^ Brander, James.A, 1987, Book Review of Greenaway and Milner (1986), Journal of International Economics 23:1/2, 182-185 ^ Davis, D.R 1995, Intra-industry trade: A Heckscher-Ohin-Ricardo approach, Journal of International Economics 39 (1995), 201-226 Environment policy, industry policy affect trade pattern New trade theory applied in Commercial business 2013/4/12 28

International trade in goods and factor mobility. By KARYIU WONG. Cambridge and London: MIT Press, 1995. Pp. xiv, 699. $60.00. ISBN 0262231794. JEL 960535 karyiu@u.washington.edu. Trade Theory and Trade Facts* Raphael Bergoeing Centro de Economa Aplicada, Universidad de Chile Timothy J. Kehoe University of Minnesota and Federal Reserve Bank of Minneapolis Reading covering: PK 119-158; RC
2013/4/12 29