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Agenda
Overview
– Course Overview: Review of Main Trade Theories
– Definition of key terms
– New Trade Theory: Paul Krugman , Nobel Price Winner
(2008)
– Intra- Industry Trade
– The Product Life Cycle Theory: Vernon (1966)
– The Porter’s Diamond of National Advantage (1990s)
Implications of the New Trade Theory
Case study: Development of Silicon Valley
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Review of Trade Theory
Question: How has international trade theory
evolved? Answer:
❑ Mercantilism (16th and 17th centuries) encouraged exports and discouraged
imports ! Protectionism
❑ Adam Smith (1776) promoted unrestricted free trade.
The Theory of Absolute Advantage : The ability of a country to produce
a product with fewer inputs than another country
❑ David Ricardo (19th century) built on Smith ideas.
The Theory of Comparative Advantage: The
notion that although a country may produce both products more cheaply than
another country, it is relatively better at producing one product than
the other
❑ Eli Heckscher and Bertil Ohlin (20th century ) refined Ricardo’s
work
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Review of Trade Theory
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Review of Trade Theory
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New Trade Theory
New Trade Theory
– Developed in the early 1980s
– Most prominent contributor was Paul Krugman, now a
New York Times columnist
Krugman won the Nobel prize (2008 ) in economics for
showing trade is caused not only by comparative
advantages, but also by external and internal
economies of scale.
Krugman showed that trade is possible & mutually
beneficial in the case of two completely identical countries
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Additional Causes of
International Trade
New Trade Theory:
There are some aspects of trade that are not readily
explained by the theory of comparative advantage. Why, for
instance, do countries trade the same kinds of goods
between each other (intra-industry trade)? This seems
intuitively to contradict what we have learned about
comparative advantage
Here we will focus on two aspects: Economies of
scale and product differentiation
This will give us a more complete understanding of the
flows of trade
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New Trade Theory
Assumptions of New Trade Theory:
In late 1980s, Helpman/Krugman coined the imperfectly
competitive framework as the “new trade theory”
One or more of
– Increasing returns to scale
– Imperfect competition
Monopoly (one seller)
Oligopoly (few sellers)
Monopolistic competition (many sellers, but each with some
market power)
– Product differentiation
None of these were allowed in the Ricardian and H-O
Models
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Definitions
imperfect competition –
firms are price setters;
firms face downward
sloping demand curves
pure monopoly –
industry with only 1 firm
oligopoly –
industry with only a few firms
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Definitions
dynamic increasing returns to scale
(dynamic economies of scale) –
average costs fall as cumulative
output over time rises
compare with:
increasing returns to scale
(economies of scale) –
o average costs fall as current output
rises
o increases in output are more than
proportional to increases in inputs
o F(aK,aL) > aF(K,L)
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Definitions : Economies of Scale
With constant return to scale, input use and total cost rise in
the same proportion as output
– Average cost is constant: total cost divided by number
of units produced is constant
With scale economies, output quantity goes up by a larger
proportion than does total cost
– Average cost per unit of output is decreasing
Note that eventually, we will always face increasing marginal costs.
Constant average costs imply:
– All factors are perfectly divisible
– The prices of factors do not increase as demand for them
increases
– Both implications demonstrably false!
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Economies of Scale and Trade
Monopolistic competition:
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Intra-Industry Trade
Net trade for an industry is the difference between exports and
imports of the industry’s product(s)
Inter-industry trade: A country exports products in some
industries and imports products in other industries
Intra-industry trade: Two-way trade in which a
country both exports and imports the same or very
similar products (i.e., products in the same industry)
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New Trade Theory Concept
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New Trade Theory
Implications of the New Trade Theory
1. Countries may export the same good to each
other
2. Countries may lose from trade
3. More and broader reasons for countries
to gain from trade
4. New rationales for using policy to affect
trade
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http://www.census.gov/foreign-trade/statistics/country/
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Intra-Industry Trade:
Measuring Intra-Industry Trade (IIT)
IIT is the total trade in the product that is not net
trade
IIT = (X + M) - | X – M |
Where X is the value of exports and M is the value of
imports of the product / group of products in question
– Definition of the “product” important for size of IIT
– The broader the definition, the greater IIT will be
Empirically, intra-industry trade is more important
for trade in manufactured goods than it is for trade in
agricultural products and raw materials
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Intra-Industry Trade for the United
States, Selected Products, 2012
U.S. Exports U.S. Imports Total Trade Net Trade Intra-Industry IIT
(X) (M) (X+M) (X-M) Trade Share
$million $millions $millions $millions $millions (%)
Perfumes (55310) 1,723 1,962 3,684 (−)239 3,445 93.5
Clothes washing
machines (77511)
205 308 512 (−)103 410 79.9
Electronic
Microcircuits (77640)
33,483 27,490 60,973 (+)5,993 54,979 90.2
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The New Trade Theory
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The New Trade Theory
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Intra-Industry Trade:
What Explains Intra-Industry Trade?
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The New Trade Theory
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New Trade Theory
Implications of the New Trade Theory
2. Countries may lose from trade
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Implications of the New Trade Theory
3. More and broader reasons for countries to gain from trade
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New Trade Theory
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Stages of the Product Cycle
One interesting hypothesis is that new products pass
through a series of stages in the course of their
development, and their comparative advantage position
changes as they move through this product cycle.
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New Trade Theory: The Product Life Cycle
Theory (Vernon, mid-1960s)
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New Trade Theory: Porter’s Diamond
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Factor Demand
Conditions Conditions
Related and
Support Industry Chance
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New Trade Theory: Porter’s Diamond
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New Trade Theory: Porter’s Diamond
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Home Diamond
(Porter, M.E. 1990)
Firm Strategy
Structure, &
Rivalry
• Do management & organisational
structures in nation match industry needs?
• Does industry attract outstanding talent?
• Do investors goals meet industry needs?
• Are there capable domestic rivals?
Demand conditions:
• Does the nation have world-class
supply industries
• Are there strong related industries
Adapted From: Porter, M.E., (1990), The Competitive Advantage of Nations, Free Press, Cited in de Wit, B & Meyer, R, (1998),
“Strategy Process, Content Context, an International Perspective” 2nd Ed, West.p, pp 775.
+ Presence
of Excellent +
Universities
+ 1
More skilled
labour.
+ Presence
of skilled
+ 5 labour
force.
+
Additional
support firms 2 +
Incoming
electronics
+ firms.
4 Component
manufacturers
attracted. +
3
Drawn by Rulzion Rattray.
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