modern trade theories

7/29/2019 modern trade theories

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Modern Trade Theories

International Economics

Chapter 3


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Chapter 3 Modern Trade Thoeries

3.1 The Existence of Intraindustry trade

3.2 Technological gap, Product life Cycle and

International Trade

3.3 Theory of Overlapping Demands

3.4 Economies of Scale, Imperfect competition,

and International Trade 3.5 Reciprocal Dumping


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3.1 The Existence of Intraindustry Trade

Advanced industrial countries have increasingly

emphasized intraindustry tradetwo-way trade ina similar commodity.

Intraindustry trade involves flows of goods with

similar factor requirements. countries that are netexporters of manufactured goods embodyingsophisticated technology also purchase such goodsfrom other countries.


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Intraindustry Trade in the U.S., 2002

( in Billion of Dollars)

Category Exports Imports

Motor Vehicles 60.39 168.1

Electrical machinery 82.7 81.2

Office machines 39.7 76.9

Telecommunications equipment 24.9 66.3

Power-generating equipment 34.4 34.0

Industrial machinery 31.8 35.2

Scientific instruments 29.2 20.9Transportation equipment 46.1 20.2

Chemicals 16.8 30.2

Apparel and clothing 8.0 63.8


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Reasons for Intraindustry Trade

Transportation costs

Seasonal

Manufacturers in each country produce for the

majority consumer tastes within their country whileignoring minority consumer tastes

Overlapping demand segments in trading countries

Economies of scale


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International Trade 3.3 Theory of Overlapping Demands




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3.2 Technological Gap, Product Life Cycle and

International Trade

Technological gap is a cause of international trade

and determines the flow of international trade.

Export of Country A and B

Time

Production of Country A

Export of Country B

Imitation Lag

T1T0 T2 T3

Production of Country B

Demand Lag

Response Lag

Grasp Lag


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International Trade

T0-T1: the stage of demand lag

the time lag from the invention of new products in innovating countries to theacceptance of importing countries.

T0-T3: the stage of imitation lag

the time interval from the invention of new products in innovating countries

to generic production until the import is zero. T0-T2: the stage of response lag

the time lag from the invention of new products to imitation of importing

countries.

T2

-T3

: the stage of grasp lag

from imitation to no import until the generic production can meet domestic

demand and turn to export.

T1-T3 is the trading period caused by technological gap.


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International Trade

The technological gap theories explain the causes of trade

among different countries from the perspective of

comparative advantage, and prove that leading technology

can form comparative advantage even among the

countries with close endowments and tastes. However, the theory hasnt explained the transfer of trade

flow and the causes of the emergence and disappearance

of technological gap.


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International Trade

The life cycle of products means all products will

experience the course of innovation, growth,

maturity and decline.

The stage of new products

The stage of mature technique

The stage of standardization


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International Trade

Model of Product Life Cycle

Time

Stage 1

Consumption in Inventing CountriesQuantity

Stage 2 Stage 3 Stage 4 Stage 5

T1 T2 T3 T4O

Export

Import

Import

Export

Production in Inventing Countries

Production in Imitating Countries

Consumption in Imitating Countries


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International Trade

O- t1

the introduction of new products

t1-t2

the growing period of products

t2-t3

the maturing period of products

t3-t4

The innovating country can manufacture the identical cheaper products than

the inventing country by native cheap non-skilled labor, sell in the

international market and compete with the inventing country. After t4

Imitation countries begin to sell products to the inventing country, and the

output of the inventing country will decrease so substantially as to come to a

full stop. And the life cycle of the products will finish.


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Wealthy (industrial) countries will likely trade with otherwealthy countries, and poor (developing) countries will

likely trade with other poor countries. The Linder

hypothesis is thus known as the theory of overlapping

demands.


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Linder does not rule out all trade in manufactured

goods between wealthy and poor countries.

There will always be some overlapping of demand

structures: some people in poor countries are wealthy,

and some people in wealthy countries are poor.However, the potential for trade in manufactured goods

is small when the extent of demand overlap is limited.



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3 4 E i f S l I f t C titi d


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3.4 Economies of Scale, Imperfect Competition, and

International Trade

Many industries are characterized by economies of scale

(also referred to as increasing returns), so that the more

efficient production is, the larger the scale at which it

takes place.



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International Trade

Where there are economies of scale, doubling the inputs to an

industry will more than double the industrys production.

Relationship of Input to Output for a Hypothetical Industry

Output Total LaborInput Average LaborInput

5 10 2

10 15 1.5

15 20 1.3

20 25 1.25

25 30 1.2

30 35 1.17


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International Trade

Economies of Scale as a Basis for Trade

Pric

e(dollars)

10,000

8,0007,500

O100 275

A

B C

Average Cost

Autos (thousands)200



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International Trade

Economies of scale provide additional cost incentives for

specialization in production.

Instead of manufacturing only a few units of each and every

product that domestic consumers desire to purchase, a country

specializes in the manufacture of large amounts of a limited

number of goods and trades for the remaining goods.

Specialization in a few products allows a manufacturer to

benefit from longer production runs which lead to

decreasing average costs.



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International Trade

Trade and Specialization under Decreasing Costs

125D

Tons of Steel100

A

United States

B

C

Computers

South

Korea



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International Trade

As South Korea moves to the right of Point A along its

PPF, the relative cost of steel continues to decreaseuntil South Korea totally specializes in steel production

at Point C.

Similarly, as the United States moves to the left ofPoint B along its PPF, the relative cost of computers

continues to fall until the United States totally

specializes in computers.

Both countries can attain consumption points that aresuperior to those attained in the absence of trade.



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International Trade

In monopolistic competition models, two key

assumptions are made to get around the problem

of interdependence.

First, each firm is assumed to be able to differentiate

its product from that of its rivals.

Second, each firm is assumed to take the prices

charged by its rivals as given.



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International Trade

Equilibrium in Monopolistically Competitive Market

Average Cost,

AC and Price, PCC

PP

Number of

Firms, n

E

n2 n3n1

AC3

P1

P2, AC2

AC1

P3

3 4 Economies of Scale Imperfect Competition and


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International Trade

The number of firms in a monopolistically

competitive market, and the prices they charge,

are determined by two relationships.On one side, the more firms there are, the more

intensely they compete, and hence the lower is theindustry price. This relationship is represented by PP.

On the other side, the more firms there are, the lesseach firm sells and therefore the higher is its average

cost. This relationship is represented by CC. The equilibrium price and number of firms occur

when price equals average cost, at the intersectionof PP and CC.

3 4 Economies of Scale Imperfect Competition and


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International Trade

Monopolistic Competition and TradeThe number of firms in a monopolistically competitive

industry and the prices they charge are affected by the

size of the market.

In larger markets there usually will be both more firms

and more sales per firm; consumers in a large market

will be offered both lower prices and a greater variety

of products than consumers in small markets.



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International Trade

An increase in the size of the market allows each firm, given other things equal, to

produce more and thus have lower average cost. This is represented by a

downward shift from CC1 to CC2.The result is a simultaneous increase in the

number of firms (and hence in the variety of goods available) and fall in the price

of each.

Average Cost, AC and Price, P

PP

Number of Firms, n

1

n2n1

P1

P2

CC2

CC1

2


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International Trade





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3.5 Reciprocal Dumping

In general, the practice of charging differentcustomers different prices is called price

discrimination.

The most common form of price discrimination ininternational trade is dumping, a pricing practice

in which a firm charges a lower price for exported

goods than it does for the same goods sold

domestically.


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Each firm has an incentive to raid the other market,selling a few units at a price that is lower than the home

market price but still above marginal cost.

If both firms do this, however, the result will be the

emergence of trade even though there is no initialdifference in the price of the good in the two markets and

there are some transportation costs.

The situation in which dumping leads to a two-way trade

in the same product is known as reciprocal dumping.

3.5 Reciprocal Dumping

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modern trade theories