International Economics: Learning Goals

06/12/2020
CHAPTER S I X
6 International Economics
Tenth Edition
NEW TRADE THEORIES:

Paul Krugman - Economies of Scale
Product Cycle Model
Michael Porter – Diamond model
Dominick Salvatore
John Wiley & Sons, Inc.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Learning Goals:
Explain how international trade can result from
economies of scale
Explain how product differentiation leads to intra-

industry trade
Understand the technological gap and product cycle

models of trade
Understand the relationship between transportation

costs and environmental standards in international
trade
1
06/12/2020
6.1 Introduction
 Two difficulties with the H-O theory:

(1) Some questions remain regarding the empirical
validity of the theory.
(2) This implies that a great deal of today's
international trade still left unexplained.
 This chapter fills this gap with some new trade

theories, which base international trade on economies
of scale, imperfect competition, and differences in the
development and spread of new technologies over
time among nations.
Introduction
 Heckscher-Ohlin theory based comparative

advantage on differences in factor
endowments among nations.
 Leaves significant portion of international

trade unexplained.
 Need complementary trade theories to fill in

the gaps.
2
06/12/2020
The Heckscher-Ohlin Model and New Trade

Theories
 Relaxing most assumptions of H-O theory

modifies but does not invalidate the theory.
 However, relaxing assumptions of perfect

competition and constant economies of scale
require complementary theories to explain
trade.
 Additional trade models required to explain
trade based on differences in technological
changes over time.
Paul Krugman & NEW TRADE

THEORY
 Almost 30 years
ago, Krugman introduced an
entirely new theory of
international trade.
 It was intended to explain
the occurrence of intra-
industry trade and was
based on an assumption
of economies of
scale whereby mass
production diminishes the
cost per unit produced.
3
06/12/2020
Economies of Scale and International Trade
Assumptions
(1) There are two nations (N1, N2) two commodities (X, Y)
(2) Both nations use the same technology in production.
(3) Both nations have the same amount of resources.
(4) Neither commodity is labor intensive or capital intensive.
(5) Both commodities are produced under increasing returns
to scale in both nations.
- i.e., Output grows proportionately more than the increase in inputs
of production. (eg., If all inputs are doubled, output is more than
doubled: Economies of scale.)
(6) Tastes are equal in both nations.
Economies of Scale and

International Trade
One of the assumptions of the H–O model was that both
commodities were produced under conditions of constant
returns to scale in the two nations (assumption 4 in Section
5.2).
With increasing returns to scale, mutually beneficial trade

can take place even when the two nations are identical in
every respect.
This is a type of trade that the H–O model does not explain.
4
06/12/2020
PPF & opportunity cost

Case 1 Case 2
Case 3 Fig. 6.1

Y
The Production Possibility Frontier

under Constant Costs
US UK
Wheat ∆ W Cloth ∆C Wheat ∆ W Cloth ∆C
180 0 60 0
150 -30 20 20 50 -10 20 20
120 -30 40 20 40 -10 40 20
90 -30 60 20 30 -10 60 20
60 -30 80 20 20 -10 80 20
30 -30 100 20 10 -10 100 20
0 -30 120 20 0 -10 120 20
10
5
06/12/2020
 Increasing returns to scale

 Production situation where output grows
proportionately more than the increase in
inputs (doubling inputs more than doubles output).
 With increasing returns to scale, mutually

beneficial trade can occur even if nations are
identical in every way.
11
FIGURE 6-1 Trade Based on Economies of Scale.

12
6
06/12/2020
FIGURE 6.1. 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 equilibrium-relative
commodity price in the two nations is identical and
given by PX/PY = 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 commodity 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.
13

International Trade
The presence of economies of scale may be seen from the fact that doubling
the input of labor from 15 to 30 more than doubles the industry's output - in
fact, output increases by a factor of 2.5.
Equivalently, the existence of economies of scale may be seen by looking at
the average amount of labor used to produce each unit of output: If output is
only 5 widgets, the average labor input per widget is 2 hours, while if output
is 25 units, the average labor input falls to 1 .2 hours.
14
7
06/12/2020
 We can use this example to see why economies of scale provide an

incentive for international trade.
 Imagine a world consisting of two countries, America and Britain,
both of which have the same technology for producing widgets, and
suppose that initially each country produces 10 widgets. According
to the table, this requires 15 hours of labor in each county, so in the
world as a whole 30 hours of labor produce 20 widgets.
 But now suppose that we concentrate world production of widgets
in one country, say America, and let America employ 30 hours of
labor in the widget industy.
 In a single country these 30 hours of labor can produce 25 widgets.
So by concentrating production of widgets in America, the world
economy can use the same amount of labor to produce 25 percent
more widgets.
15

International Trade
 Increasing returns to scale may occur because at a
larger scale of operation a greater division of labor
and specialization becomes possible. That is, each
worker can specialize in performing a simple
repetitive task with a resulting increase in
productivity.
 Furthermore, a larger scale of operation may
permit the introduction of more specialized and
productive machinery than would be feasible at a
smaller scale of operation.
 Antweiler and Trefler (2002) found that a third of all
goods-producing industries are characterized by
increasing returns to scale.
16
8
06/12/2020
 The H-O model assumes that opportunity costs

increase as production within a nation increases.
This produces a ppf that is concave from the origin,
which was used in Chapters 3-5.
 If, however, increased production makes possible a
greater specialization of labor and/or capital, or
other forms of cost savings, then opportunity cost
may decrease as production increases which, is
known as economies of scale. (The term
“economies of scale” refers to any reduction in cost
due to an increase in production in a firm.
17
Related Sources of International Trade

(1) International economies of scale (Case Study 6-1)
- Products manufactured by international corporations
have parts and components made in many different
nations.
- 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.
- E.g., The New International Economies of Scale
(Case Study 6-1)
18
9
06/12/2020
19
Increasing returns to scale

Significant international economies of scale
from:
Outsourcing
purchase by firm firm producing in

of parts and its own plants
components abroad some of
abroad in order the parts and
to keep costs components used
down. in its products.
Offshoring
20
10
06/12/2020
Outsourcing
 Japanese and German cameras are often

assembled in Singapore to take advantage of
cheaper labor there
 Apple, one of the most successful brands in
the tech industry today, barely does its own
manufacturing work, yet profits are
consistently skyrocketing.
 They outsource most of the labor-intensive
work to China and numerous other countries
around the world to save up on production
time.
21
Imperfect Competition and International

Trade: Trade Based on Product Differentiation
22
11
06/12/2020

Trade: Trade Based on Product Differentiation
intra-industry trade
•in differentiated
products
inter-industry trade
• in completely different
products.
23
Case Study 6-3 U.S. Intra-Industry Trade in

Automotive Products
24
12
06/12/2020

Trade
Exchange of differentiated
products of the same
industry
Intra-industry trade in
differentiated products
Economies of scale in
production.
25

Trade
 Contrasts to H-O Model

1. Trade in H-O model based on factor endowment
differentials, but intra-industry trade is based on
product differentiation and economies of scale,
and will likely be larger for nations of similar
size and factor proportions.
2. With differentiated products produced under
economies of scale, pretrade-relative commodity
prices may not accurately predict patterns of
trade as they do under H-O model.
26
13
06/12/2020

Trade
 Contrasts to H-O Model

3. H-O model predicts trade will lower returns of
nation’s scarce factor. With intra-industry trade
based on economies of scale, it is possible for all
factors to gain.
4. Intra-industry trade is related to sharp increases
in international trade in parts and components of
a product, or outsourcing.
27

Trade
Comparative Economies of scale in

advantage seems to differentiated
determine patterns of products gives rise to
inter-industry trade. intra-industry trade.
• More likely with • More likely with similar
dissimilar factor factor endowments.
endowments.
28
14
06/12/2020
Imperfect Competition and International Trade

 Key characteristics of Intra-industry trade:
(1) While inter-industry trade (eg., trade in the H-O

model) is based on comparative advantage among
nations, intra-industry trade is based on product
differentiation and economies of scale.
(2) With intra-industry trade, pretrade-relative
commodity prices may no longer accurately predict
the pattern of trade.
(3) While the H-O model predicts that trade will lower
the return of the nation's scarce factor, with intra-
industry trade it is possible for all factors to gain.
29
Imperfect Competition and International Trade

 Key characteristics of Intra-industry trade:
(4) Intra-industry trade is related to the sharp increase in

international trade in parts and components of a
product.
(5) Intra-industry trade arises more between nations with

similar tastes and income levels.
(6) While most of the trade between developed and

developing countries is inter-industry trade, an
increasing proportion of the trade among industrial
countries is intra-industry trade.
30
15
06/12/2020
Cluster of cutlery manufacturers in

Sheﬀield
31
The Theory of External Economies
Semiconductor
Investment banking
industry in
industry in New
California's famous
York
Silicon Valley
the entertainment
industry in
Hollywood.
32
16
06/12/2020
The Theory of External Economies
economies of scale at the level of the firm (imperfect

competition) => internal economies of scale
economies of scale at the level of the industry =>

external economies
The concentrating production of an industry in one or a

few locations reduces the industry's costs, even if the
individual firms in the industry remain small.
33
SUMMARY
 Trade need not be the result of comparative
advantage. Instead, it can result from
increasing returns or economies of scale, that is,
from a tendency of unit costs to be
lower with larger output.
 Economies of scale give counties an incentive to
specialize and trade even in the absence of
diﬀerences between countries in their resources or
technology.
 Economies of scale can be internal (depending on
the size of the firm) or external (depending on the
size of the industry).
34
17
06/12/2020
Trade Based on Dynamic

Technological Differences
Product cycle model – A dynamic

extension of the static H–O model
35
Trade Based on Dynamic Technological

Differences
What are the relatively What are the relatively

abundant factors in abundant factors in
developed nations? developing nations?
36
18
06/12/2020

Differences
What are the relatively What are the relatively

abundant factors in abundant factors in
developed nations? developing nations?
• highly skilled labor • Cheap labor
• expenditures on
research &
development
37
The product cycle model

tries to explain dynamic
comparative advantage for
new products and new
production processes
The basic H–O model

explains static comparative
advantage.
38
19
06/12/2020

Differences
 According to these models, the most highly

industrialized economies are expected to
export nonstandardized products embodying
new and more advanced technologies and
import products embodying old or less
advanced technologies.
 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.
39
Trade Based on Dynamic

Technological Differences
 A classic example of the product cycle model is provided by the
experience of U.S. and Japanese radio manufacturers since
World War II. (p173)
 Immediately after the war, U.S. firms dominated the
international market for radios, based on vacuum tubes
developed in the United States.
 However, within a few years, Japan was able to capture a large
share of the market by copying U.S. technology and utilizing
cheaper labor.
 The United States recaptured technological leadership with the
development of transistors. But, once again, in a few short years,
Japan imitated the technology and was able to undersell the
United States.
 Subsequently, the United States reacquired its ability to compete
successfully with Japan by introducing printed circuits.
40
20
06/12/2020
A classic example of the product

cycle model
Audio vacuum tubes in Sony transistor radio TR-

Regency TR-1
radio 55
Original 1979 Sony

Printed circuit
Walkman TPS-L2
41

Differences
 Note that trade in these models 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 over time.
42
21
06/12/2020
FIGURE 6-4 The Product Cycle Model.
43

Differences
 FIGURE 6.4. The Product Cycle Model.

 In stage I (time OA), the product is produced and consumed
only in the innovating country.
 In stage II (AB), production is perfected in the innovating
country and increases rapidly to accommodate rising demand at
home and abroad.
 In stage III (BC), the product becomes standardized and the
imitating country starts producing the product for domestic
consumption.
 In stage IV (CD), the imitating country starts underselling the
innovating country in third markets, and in stage V (past point
D) in the latter’s market as well.
44
22
06/12/2020
Product Cycle Model (Vernon, 1966)
 Advanced industrialized countries develop and

introduce new products, with temporary monopoly
power as the sole exporter of the product.
 As the technology producing the product becomes
more widespread, production will spread to other
nations.
 This moves international trade to a standard
comparative advantage framework
 As production becomes standardized, the original
introducer of the product loses its technologically
based comparative advantage in the production of
the product and becomes an importer of the product.
45
Transportation costs &

Environmental Standards
INFLUENCE International Trade
Costs of Environmental
Transportation Standards
International
Trade
46
23
06/12/2020
Transportation costs
 Transport, or logistics, costs are the freight charges, warehousing

costs, costs of loading and unloading, insurance premiums, and
interest charges incurred while goods are in transit between
nations.
47
Costs of Transportation and

Nontraded Commodities
 Nontraded goods and services are goods for
which transport costs exceed price differences
across nations.
 Homogeneous goods will be trade
internationally only if the pretrade price
difference exceeds transport costs.
 Examples:
 Cement is not traded internationally because of
its high weight-to-value ratio.
 Average people do not travel from New York to
London for a haircut.
48
24
06/12/2020
Transport costs influence location of

production and industry:
Resource-oriented industries
• locate near the source of raw materials used by the
industry.
Market-oriented industries
• produce goods that become heavier or more difficult to
transport during production, so they locate near the
markets for their products.
Footloose industries
• face neither substantial weight gains nor losses during
production, and can locate where availability of other
inputs leads to lower manufacturing costs.
49
Environmental standards
 Refers to levels of air, water and thermal pollution

resulting from garbage disposal that a nation allows.
50
25
06/12/2020
Thermal Pollution As The Unseen

Side Of Water Pollution
Thermal pollution
in the broadest
sense can be
defined as the
abrupt change in
ambient
temperature of a
natural water
body by any
human induced
processes.
The increase or decrease of water temperature degrades the quality of

water and makes it unfit for consumption or the life-systems of aquatic
organisms. It could happen in lakes, rivers, oceans or even ponds.
https://geographyandyou.com/thermal-pollution-unseen-water-pollution/
51
Environmental Standards INFLUENCE

Industry Location, and International Trade
As a resource
endowment or
as a factor of
production A comparative
Lower
advantage in
environmental
polluting goods
standards
and services.
52
26
06/12/2020
Environmental Standards INFLUENCE

Industry Location, and International
Trade
 A nation with lower environmental standards can use the

environment as a resource endowment or as a factor of
production in attracting polluting firms from abroad and
achieving a comparative advantage in polluting goods
and services.
53
Environmental standards
54
27
06/12/2020
Determinants of international
trade
Differences in relative factor
abundance [factor endowments]
international trade
Determinants of among nations
Economies of scale and product

differentiation
Dynamic changes in relative factor

abundance (technology) among
nations over time
Costs of transportation &

environmental standards
55
Case Study 6-5 Growth of Intra-Industry Trade
56
28
06/12/2020
Case Study 6-6 Intra-Industry Trade Indexes

for G-20 Countries
57
THE PORTER DIAMOND MODEL – ANALYSIS OF

NATIONAL COMPETITIVENESS
influence how successful

explain the international the company can
competitiveness of the become in other
firm. markets.
Characteristics
[quality] of the
home country
environment
Chúc các em thi tốt nhe!
58
29
06/12/2020
THE 6 ELEMENTS OF THE PORTER DIAMOND

MODEL
Firm
Related and
strategy,
supporting
structure
industries
and rivalry
Demand
Chance
conditions
Factor National
Government
conditions competitiveness
59
THE PORTER DIAMOND MODEL – ANALYSIS OF

NATIONAL COMPETITIVENESS
 The Porter Diamond model offers an effective way

for analysing the national competitiveness.
 Based on the characteristics of the home country, it
is possible to assess the international success of the
firm.
 According to the Porter Diamond model, the
characteristics of the home country play a central
role in explaining the international competitiveness
of the firm.
 Thus, it asserts that the quality of the home country
environment influence how successful the
company can become in other markets.
60
30

International Economics: Learning Goals

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

International Economics: Learning Goals

Uploaded by

Copyright:

Available Formats

06/12/2020

NEW TRADE THEORIES:

Explain how product differentiation leads to intra-

Understand the technological gap and product cycle

Understand the relationship between transportation

 Two difficulties with the H-O theory:

 This chapter fills this gap with some new trade

 Heckscher-Ohlin theory based comparative

 Leaves significant portion of international

 Need complementary trade theories to fill in

The Heckscher-Ohlin Model and New Trade

 Relaxing most assumptions of H-O theory

 However, relaxing assumptions of perfect

Paul Krugman & NEW TRADE

Economies of Scale and International Trade

(6) Tastes are equal in both nations.

Economies of Scale and

With increasing returns to scale, mutually beneficial trade

PPF & opportunity cost

Case 3 Fig. 6.1

The Production Possibility Frontier

Economies of Scale and International Trade

 Increasing returns to scale

 With increasing returns to scale, mutually

FIGURE 6-1 Trade Based on Economies of Scale.

FIGURE 6.1. Trade Based on

Economies of Scale and

 We can use this example to see why economies of scale provide an

Economies of Scale and

 The H-O model assumes that opportunity costs

Economies of Scale and International Trade

Related Sources of International Trade

Economies of Scale and International Trade

Increasing returns to scale

purchase by firm firm producing in

 Japanese and German cameras are often

Imperfect Competition and International

Imperfect Competition and International

Case Study 6-3 U.S. Intra-Industry Trade in

Imperfect Competition and International

Imperfect Competition and International

 Contrasts to H-O Model

Imperfect Competition and International

 Contrasts to H-O Model

Imperfect Competition and International

Comparative Economies of scale in

Imperfect Competition and International Trade

(1) While inter-industry trade (eg., trade in the H-O

Imperfect Competition and International Trade

(4) Intra-industry trade is related to the sharp increase in

(5) Intra-industry trade arises more between nations with

(6) While most of the trade between developed and

Cluster of cutlery manufacturers in

The Theory of External Economies

The Theory of External Economies

economies of scale at the level of the firm (imperfect

economies of scale at the level of the industry =>

The concentrating production of an industry in one or a

Trade Based on Dynamic

Product cycle model – A dynamic

Trade Based on Dynamic Technological

What are the relatively What are the relatively

Trade Based on Dynamic Technological