Download Intra-industry trade based on economies of scale and imperfect

广东省省级精品课程《国际贸易》
Chapter 5
Modern International Trade
Theories
刘
芹
Chapter 4
Modern International Trade
Theories

In this chapter, we will examine
(1)
The emergence and development of modern
trade theories;
Intra-industry trade based on economies of
scale and imperfect competition;
Int’l trade based on differences in dynamic
changes in technology among nations;
Int’l trade based on demand preference.
(2)
(3)
(4)
§1
Introduction
1.1 Background

H-O model faces two difficulties in modern
time. One is that some questions remain
regarding the empirical validity of the theory.
More important is that some of the
assumptions on which the theory leaves a
great deal of today’s international trade
unexplained.
H-O
New trade’s characters after World War II:
(1) an increase in trade volume between similar
products;
(2) an increase in trade volume among the
nations who have similar development level;
(3) an increase in transfer speed in the
advanced sectors.


1.2 the Development Track of
Modern Trade Theories



In the 1950s, the query on Leontief Paradox.
In the 1960s, new trade basis on dynamic
technology change supposed by Linda and
Vernon.
In the end of 70s or the beginning of 80s,
“New Trade Theory” advanced by Krugman,
who was the first economist exploring
modern trade and building trade model
based on economy of scale and imperfect
competition, is the greatest man of modern
trade theories.
•Paul Krugman was born in
American middle-class family in
1953. He graduated from John F
Kennedy high school and studied
economy in famous MIT. Now he is
professor of economics. His main
researches lie within international
trade, international finance,
monetary crisis and exchange
rate’s fluctuation. New trade theory
built by Krugman explained income
increase and incomplete
competition’s impacts on
international trade.
1.3 the relationship between H-O
Model and New Trade Theories


Modern trade theories are generated and developed
on the basis of traditional trade theories. They are
complementary, not substitute, enriching and
developing international trade theory system
together.
As for the study object, the former explain intraindustry trade among developed countries, the
latter explain inter-industry trade between
developed and developing countries. As for the
theory basis, the former is based on economies of
scale and imperfect competition, the latter is based
on constant returns to scale and perfect
competition.
In the following five prerequisites, the
relative prices across nations are same in
isolation.
(1) no differences in technological change
among nations;
(2) same factor abundance;
(3) equal tastes across nations;
(4) constant returns to scale;
(5) perfect competition.

§2 Intra-industry Trade on Economies
of Scale and Imperfect Competition
2.1 Economies of Scale



Economies of Scale, that is, increasing returns to
scale mean that the output grows proportionally
more than the increase in inputs or factor of
production, e.g. a 10% increase in input leads to
more than 10% increase in output.
It occurs because at a large scale of production a
greater division of labor and specialization becomes
possible. A larger scale of operation may permit the
introduction of more specialized and productive
machinery than at a smaller scale of operation.
About a third of all goods-producing industries are
characterized by increasing returns to scale in the
world today.
Two Forms of Economies of Scale:



Internal economies of scale refer to the
reduction in the average costs of production
as the firm’s output expands. Increasing
returns to scale are internal to a firm.
External economies of scale refer to the
reduction in each firm’s average costs of
production as the entire industry output
expands.
For example:


External economies of scale arise because a
larger and more geographically concentrated
industry is likely to provide more specialized
labor and other services, thus leading to
higher productivity and lower average costs
for all the firms in the industry.
This is the reason that so many computer
companies are clustered in California’s
Silicon Valley and financial institutions and
banks are concentrated in New York City.
2.2 Trade Based on Economies of Scale

With identical and convex to the origin (because
of economies of scale) production frontiers and
indifference maps, the no-trade equilibriumrelative commodity price in the two nations is
identical and given by PA. With trade, Nation 1
could specialize completely in the production of
commodity X and produce at point B. Nation 2
would then specialize completely in the
production of Y and produce at point B’. By then
exchanging 60X for 60Y with each other, each
nation would end up consuming at point E on
indifference curve II, thus gaining 20X and 20Y.
We must clarify the following:
 First of all, it is a matter of complete indifference as
to which of the two nations specializes in the
production of commodity X or Y. In the real world,
this may result from historical accident.
 Second, the two nations need not be identical in
every respect for mutually beneficial trade to result
from increasing returns to scale.
 Third, during the past decade or so, there has been a
sharp increase in international trade in parts and
components, as well as in setting up of production
facilities abroad, and these have been the source of
new and significant international economies of scale.
CASE STUDY 4-3
2.3 Internal Economy of Scale, Monopoly
Corporation and Intra-industry Trade
Japan
U.S.
C,P
C,P
2.0
2.0
1.5
LAC
0
100
200
Export to U.S
Truck
LAC
0
100
Truck
C,P
C,P
2.0
2.0
1.5
LAC
0
100
Car
LAC
0
100
200
Export to Japan
Car

The meanings of economies of scale:
whether there is a difference in relative
prices across nations, it will bring the
nations to specialize in the production of
some commodities so that they can obtain
more gains from economies of scale. In
addition, as to the commodities the
consumers require, some is from domestic
supply, others from abroad.
2.4 imperfect competition market
Commodity structure in all sectors
(differentiated products);
 Producers’ scale and their impacts on
market.



A great deal of international trade can and
does involve the exchange of differentiated
products of the same industry or broad
product group. That is intra-industry trade,
as opposed to inter-industry trade in
completely different products.
differentiated products are the somewhat
different products (such as automobiles,
cigarettes, and soaps) produced by different
manufacturers in the same industry or
general product group. The difference can be
in brand, quality, design, performance,
packing, terms of payment, advertisement,
services, and so on.
Different Demand Curves in
Different Market Structure
P
Perfect
competition
Monopolistic
competition
monopoly
Q
2.5 Price Discrimination





Price Discrimination refers to the situation that
monopoly or monopolistic competition corporations
regulate different price in different markets or to
different consumers when they sell the same
products. It is called “Dumping” in international
trade.
Dumping is possible under three conditions:
◆imperfect competition
◆market division
◆different demand elasticity in different market
(Df ＞Dh)
Economics analysis of dumping
Foreign Market
Domestic Market



The horizontal axis shows quantities and the
vertical axis shows prices. The left
represents the situation in foreign market
and the right in domestic market.
When MR=MC, producers get a maximum
profit. Producers supply Qh at Ph in
domestic market and supply Qf at Pf in
foreign market.
Since Df>Dh, the demand curve is flatter in
foreign market. That is to say, producers can
sell more goods in foreign market than in
domestic market if they reduce prices at the
same rate in both markets. So producers are
willing to sell their goods at a lower price in
foreign market to get more benefit.
Enlarge market share domestically
or Enhance Export Abroad?





A manufacturer sells 1000 units in domestic
market and 100 units in foreign market.
Ph=$20，Pf=$15.
Wherever the manufacturer sells one more
unit at home or abroad, he must decline the
price.
If he decline ¢1 in both markets, that is,
Ph=$19.99，Pf=$14.99
MRh=1001×19.99－1000×20=9.99
MRf=101×14.99－100×15=13.99
◆MR：Although Pf is lower than Pd, MRf is
larger------To expand export is better than to
enlarge market share; MRh decreases more
quickly------the manufacturer must control
domestic quantities.
◆the relation between market share and price:
Owing to transportation cost, trade barriers
and large domestic market share，the extent
of decreasing price is different in both
market.
◆monopoly power: Owing to small foreign
market share, the manufacture has no power
to decide the price.
2.6 Intra-industry Trade



Inter-industry trade and Intra-industry trade
The former means the international trade
taken place between industries and the latter
means the trade in the same industry.
Intra-industry trade involves the exchange of
differentiated products. They are produced in
the same industry but with different designs
and brands.
Reasons for Intra-industry trade

Intra-industry trade arises in order to make use of
economies of scale in production. That is,
international competition forces each firm or plant to
produce few varieties of the same product rather
than many different varieties to reduce the costs.
With few varieties and styles, more specialized and
faster machinery can be developed for a continuous
operation and a longer production run.
Who will benefits from the trade?

The producers will benefit because they can produce
at lower costs. The consumers will have wider range
of choices and will buy them at lower prices.




Comparative advantage seems to determine the
pattern of inter-industry trade, while economies of
scale in differentiated products give rise to intraindustry trade.
The more similar nation are in factor endowments
and technology (as among developed countries), the
smaller is the importance of inter- relative to intraindustry trade, and vice versa.
Since industrial nations have become more similar in
factor endowments and technology over time, the
importance of intra- relative to inter-industry trade
has increased.
Lancaster (1980): Inter-industry trade reflects natural
comparative advantage while intra-industry trade
reflects acquired comparative advantage.
2.7 Measuring Intra-Industry Trade

Intra-industry trade index ( IIT )
• IIT = 1 - IX – MI / (X + M)
 Where X and M represent, respectively, the
value of exports and imports of a particular
industry or commodity group.
 If X=0,or M=0, IIT=0, NO intra-industry trade.
 If X=M IIT=1, intra-industry trade is maximum.
 CASE STUDY 4-4

Note: There is a serious shortcoming in
using the index IIT to measure the degree of
intra-industry trade. This results from the
fact that we get very different values for T,
depending upon how broadly we define the
industry or product group. Specifically, the
more broadly we define an industry, the
greater will be the value of T. Thus, the T
index must be used with caution. It can,
nevertheless, be very useful in measuring
differences in intra-industry trade in different
industries and changes in intra-industry
trade for the same industry over time.
§3 Trade Based on Dynamic
Technological Differences

Apart from differences in the relative
availability of labor, capital, and natural
resources (stressed by the H-O theory) and
the existence of economies of scale and
product differentiation, dynamic changes in
technology among nations can be a separate
determinant of international trade. These are
examined by the technological gap and
product cycle models. Since time is involved
in a fundamental way in both of these models,
they can be regarded as dynamic extensions
of the static H-O model.
3.1 Technological Gap Model

According to the technological gap model
sketched by Posner in 1961, a great deal of
the trade among industrialized countries is
based on the introduction of new products
and new production processes. These give
the innovating firm and nation a temporary
monopoly based on patents and copyrights,
which are granted to encourage inventions.


As the most technologically advanced nation, U.S.
exports a large number of new high-technology
products. However, as foreign producers acquire the
new technology, they eventually are able to conquer
markets abroad, and even the U.S. market for the
product, because of their lower labor costs.
Meanwhile, U.S. producers may have introduced still
newer products and production processes and may
be able to export these products based on the new
technological gap established.
CASE STUDY 4-5
Nation A’s Production
and Consumption
Nation A’s
Production
To
T1
T2
Nation B’s
Productio
n
Nation B’s Production
and Consumption
T3
T4
Nation B’s
Export
Time
Nation A’s
Imports
To---T1: Demand lag;
To---T2: Response lag;
T2---T3: Control lag in technology;
To---T3: Imitation lag;
T1---T3:Trade period
3.2 Product Cycle Model


A shortcoming of the technological gap
model, however, is that it does not explain
the size of technological gaps and does not
explore the reason that technological gaps
arise or exactly how they are eliminated over
time.
A generalization and extension of the
technological gap model is the product cycle
model developed by Vernon in 1966.



When a new product is introduced, it usually
requires highly skilled labor to produce. As the
product matures and acquires mass acceptance, it
becomes standardized; it can then be produced by
mass production techniques and less skilled labor.
Comparative advantage in the product shifts from
the advanced nation that originally introduced it to
less advanced nations, where labor is relatively
cheaper.
eg: radio This may be accompanied by technology
trade, foreign direct investments and foreign trade
from the innovating nation to nations with cheaper
labor.
A product goes through three stages:
(1) The phase of introduction: The product is produced
and consumed only in the innovating country.
production is increased rapidly to accommodate
rising demand at home and abroad.
(2) The phase of maturation: The innovating firm may
find it profitable to license other domestic and
foreign firms to also manufacture the product. The
imitating country begins to undersell the product
in third markets, and production of the product in
the innovating country declines.
(3) The phase of standardization: The imitating country
starts underselling the product in the innovating
country where the production declines rapidly or
collapses.
Product Cycle Model
欠发达国家
净出口
t0
净进口
其它工业国
t1
t2
t3
t4
t5
Time
领先国：美国
第一阶段：创新
领先国家出口
第二阶段：技术扩
散跟随者出口
第三阶段：技术停
滞欠发达国家出口
Characters Change in Each Stage:






Production Location:
The most advanced nation --- other
developed nations ---the developing nations;
Comparative Advantage:
Technology-intensive products --- Capitalintensive products --- Labor-intensive
products
Demand Change:
Innovative nation and other developed
nations --- all developed nations --- all the
world
3.3 Difference between Technological
Gap Model and Product Cycle Model
•Technological gap model emphasizes the time
lag in the imitation process. The product cycle
model stresses the standardization process.
•According to these models, the most highly
industrialized nations are expected to export
non-standardized products embodying new and
more advanced technologies and import
products embodying old and less advanced
technologies. On the other hand, developing
nations import non-standardized products and
export standardized products.



Note that in these two models trade is originally
based on new technology developed by the relatively
abundant factors in industrialized nations (such as
highly skilled labor and expenditures on research
and development).
Subsequently, through imitation and product
standardization, less developed nations gain a
comparative advantage based on their relatively
cheaper labor.
As such, trade can be said to be based on changes
in relative factor abundance (technology) among
nations.
§4 Trade Based on Demand
4.1 Factors of Deciding
Demand
 Real Demand
 Preference
 Income
4.2 Income Elasticity and Engle Law
Income Elasticity (η)
1. η＞1，luxuries
2. 0<η<1，necessities
3. η＜0，inferior goods
 Engle Law: With income increasing, the
ratio of expenditure on foods will
decrease more and more.

4.3 Preference Similarity theory


The hypothesis was advanced by Linder in 1961 that
a nation exports those manufactured products for
which a large domestic market exists.
These are products that appeal to the majority of the
population. In the process of satisfying such a
market, the nation acquires the necessary
experience and efficiency to be able subsequently to
export these commodities to other nations with
similar tastes and income levels. The nation will then
import those products that appeal to its low- and
high-income minorities.
Product
Quality
Pw
b
Overlapping Demand
a
Similar
Income
O
Nation 1
Nation 2
Income



According to preference similarity or overlapping
demands hypothesis, trade in manufactures is likely
to be the largest among countries with similar tastes
and income levels.
If their incomes and tastes are similar, they would
consume the same kind of commodities. So there
would be some trade among them.
While confirmed for his native Sweden, Linder’s
hypothesis has not been confirmed for other nations.
It also cannot explain, for example, why China
exports artificial Christmas trees in the absence of a
domestic market for these products.
4.4 Trade Based on Different Taste
If the production possibility frontiers
are identical, is there any basis for trade?
The basis for trade is the difference in tastes or
demands. The nation with a smaller demand for
a commodity will have a lower autarky relative
price for, and a comparative advantage in the
commodity.
wheat
rice
Key Terms
Increasing returns to scale
 External economies
 Differentiated products
 Intra-industry trade
 Intra-industry trade index
 Technological gap model
 Product cycle model

Questions for Review
1. What are two important limitations of the HO theory?
2. What is meant by economies of scale? How
can they be the basis for international trade?
3. What is meant by product differentiation?
Why does this result in imperfect
competition? How can international trade be
based on product differentiation?
4. How can intra-industry trade be measured?
What are the shortcoming of such a measure?
5. How can international trade take place
according to the technological gap
model? What criticisms are leveled
against this model? What does the
product cycle model postulate? What
are the various stages in a product life
cycle?
6. what is the empirical relevance of the
H-O model and the new trade theories?
Problems
1. Draw a figure similar to the figure
“Trade Based on Economies of Scale”,
showing how mutually beneficial trade
can take place between two nations
based on economies of scale if the
nations have identical production
frontiers but different tastes.
Demand: Engel Law
Supply: Rybczyski Theorem
Economic Growth
(Dutch Disease and
and Trade
ImmiserizingGrowth)
Improvement in Technology
Intra-industry Trade theory
Based on Economy of Scale
and Incomplete Competitiveness
Modern Trade Theory
Technological Gap theorem
and Product Cycle Theory
Overlapping Demand Theory
(Preference Similarity Theory)
Leontief Paradox
H-O Theorem
Neo-classical Trade Theory
(H-O Model)
H-O-S Theorem
Specific-factor Model
(Factor-price
Equalization Theorem) Stolper-Samuelson T
Absolute Advantage Theory
Classical Trade Theory
Reciprocal
Comparative Advantage Theory Demand Theor