International Trade Theory

and Policy
Lecture 10 – Product Life Cycle
Trade Theory
 Product Cycle Model
• Product Cycle Model explains trade based on
technological differences
• When a new product is introduced by a firm in a
market, it requires highly skilled labor for production
• As the product matures in production, its production
process standardizes
• After maturity, it can be produced by low skilled labor,
using mass production
• Therefore, the comparative advantage that the
innovating country had, now shifts to a country which
has lower costs
• We call this country with lower labor costs as imitating
country
The Product Cycle model
 The Five Stages of Production
• Stage 1 – new product phase
– Production and consumption in the innovating
country only
• Stage 2 – product growth phaze
– production is perfected in the innovating country
– Production caters to rising demand at home and
abroad
– No foreign production of the product
– innovating country has a monopoly in both the
home and export markets
 The Five Stages of Production
• Stage 3 – product maturity phaze
– Production process becomes standardized
• Standardization implies that the production process can
be broken down efficiently into sub processes
• This means that production process does not require
any innovation
• Standardization makes an imitating country start
production
– innovating firm may find it profitable to license
other domestic and foreign firms to also
manufacture the product
– Imitating country starts to produce the product for
domestic consumption
 The Five Stages of Production
• Stage 4 – product decline stage
– the imitating country, facing lower labor and other
costs now that the product has become
standardized and no longer requires development
and engineering skills
– begins to undersell the innovating country in third
markets
– production of the product in the innovating
country declines
– Brand competition now gives way to price
competition
 The Five Stages of Production
• Stage 5 - product decline stage
– the imitating country starts underselling the
innovating country in the latter’s market as
well
– production of the product in the innovating
country declines rapidly or collapses
– Technological diffusion, standardization, and
lower costs abroad thus bring the end of the
life cycle for the product
 Reading
• Salvatore Chap 6, Section 6.4 (I guess!!!)