The New Trade Theory • Emerged in the 1970s by

Transcript:The New Trade Theory • Emerged in the 1970s by:
The New Trade Theory • Emerged in the 1970s by a number of economists • Countries do not necessarily specialize and trade solely to take advantage of their differences in resource endowments or technology • They also trade because of increasing returns that makes specialization advantageous in some industries • New trade theorists introduce industrial organization view into trade theory and include real-life imperfect competition in international trade • Argue that because of economies of scale, there are increasing returns to specialization in many industries Economies of Scale and International Trade: Definitions: • Economies of Scale: Reduction of average cost as a result of increasing the output • Increasing Returns: a unit increase in inputs results in more than one unit increase in output • Economies of scale is an important source of increasing returns to specialization • New Trade Theory supports the Comparative Advantage theory by identifying economies of scale as an important source of comparative advantage. • Domestic market may not be big enough to realize economies of scale for certain products Ex: the aerospace industry dominated by Boeing and Airbus How do they achieve economies of scale? • First-mover Advantage: New Trade Theory suggests that a country may predominate in the export of a good simply because it was lucky enough to have one or more firms among the first to produce that good • First mover’s ability to benefit from increasing returns creates a barrier to entry Ex: Microsoft operating systems, Apple’s iPod, Google, etc. Economies of Scale and Market Structure How international trade take place? • When there is economies of scale, large firms have cost advantage over small ones and lead to imperfectly competitive market structure (ACLarge < ACSmall) • Each country specializes in producing a restricted range of goods taking advantage of economies of scale • Helps them to produce these goods more efficiently than if tried to produce everything by itself • Specialized economies trade with each other, making possible to consume the full range of goods (variety of consumption) Theory of Imperfect Competition Characteristics • A few major producers • Differentiated products • Firm is a ‘price setter’ not ‘price taker’ • Firms can sell more only by reducing their prices (downward slopping demand curve) Monopolistic Competition and Trade • In autarky, variety of goods and scale of production are constrained by size of the market • Trade increases market size