ECON 321 INTERNATIONAL ECONOMICS Chapter 6 NEW TRADE THEORIES

Introduction This chapter deals with New Trade Theories which uses the following concepts to explain the recent trade pattern: International trade can result from economies of scale Imperfect Competition affects international trade Trade based on technological differences

H-O Model and New Trade Models Relaxing assumptions of H-O does not invalidate the theory but requires some more theories to explain the trade Specially the assumptions of constant economies of scale and perfect competition. Other assumptions of 2x2x2, factor intensity, factor abundance can all be released

Assumptions of H-O 2x2x2 model assumption is not valid in reality when more than 2 countries, more than 2 goods and more than 2 factors (no more factor intensity for goods) Same technology in all countries assumption, where is not the case (differences in technology as well as changing technology in time forms the Dynamic extensions of theory Constant Returns to Scale (where increasing returns to scale with scale economies both externally and internally is possible) Perfect competition assumption (inclusion of theory of imperfect competition explains more cases of today trade patterns)

Overlapping Demands Domestic countries produce goods targeted at tastes and income levels of the domestic market Good is exported to other countries with similar tastes and income levels Similar goods may be imported that target different tastes/income levels in developing country

Overlapping Demands (cont) US car manufacturers make cars that satisfy tastes and income levels of US market Some individuals in US market do not prefer US cars They may prefer the cars produced in Germany that have been produced to target German tastes/income levels

LINDER’s Hypothesis Some German consumers may prefer US cars This exchange leads to intraindustry trade Linder states that high income countries will trade with other high income countries since income determines general tastes/preferences

Economies of scale model of trade Some productive relationships are characterized by increasing returns to scale. A production situation where output grows proportionally more than the increase in inputs to the productive process. A doubling of inputs more than doubles outputs.

Economies of scale model of trade (2) Some productive relationships are characterized by increasing returns to scale. In this situation, production on a larger scale lowers per unit costs of production and provides a new source of cost advantage on which to base exports.

Monopolistic Competition Many firms each with some market power Products are differentiated Ex: Fast food restaurants, gas stations Must compete with other firms offering close substitutes

Trade based on Differentiated Products Most intraindustry trade is in differentiated products These have features that make them appear different from competing goods in same market or industry Ex: computers have different components or specifications Sport shoes or cars with different brands

Trade Based on Product differentiation Differentiated products Similar products produced by different manufacturers in the same industry or general trade group. Toyota and Ford automobiles are differentiated products

Trade Based on Product differentiation Differentiated products Intra-industry trade may arise from product differentiation. Intra-industry trade is international trade in differentiated products.

Reasons for intra-industry trade Allows producers to exploit product specific economies of scale. Allows consumers to benefit from product variety that would not exist without international trade.

Interindustry v. Intraindustry Interindustry trade – the exchange or trade of different goods Cloth for Machines Intraindustry trade – the exchange or trade of the same or very similar goods Computers for computers

Intraindustry trade index Where X value of exports M value of imports

Index Values Index ranges from 0 to 1 0 index value means (no intraindustry trade) whereas 1 (100 percent intraindustry trade) The closer to 0, the less intraindustry trade relative to interindustry trade The closer to 1, the more intraindustry trade relative to interindustry trade

Weaknesses of Intrainindustry Values of intraindustry trade depending on how a particular industry or product group is defined changes More broadly defined groups will show more intraindustry trade Ex: Pants More narrowly defined groups will show less intraindustry trade Ex: women’s pants and men’s pants

The product cycle model of trade Advanced industrialized countries develop and introduce new products While only one country possess the product, it possesses international monopoly power and will be the sole exporter of the product.

The product cycle model of trade Advanced industrialized countries develop and introduce new products 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.

The product cycle model of trade Advanced industrialized countries develop and introduce new products As the technology producing the product becomes more widespread, production will spread to other nations. 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.

Product Cycle Model. Four stages of development

Product Cycle Stage 1 New products need high income markets as prices are relatively high R&D and production improvements require inputs in developed countries May export to other developed countries but mainly consumed in innovating country

Product Cycle Stage 2 Production perfected in the innovating country and increases rapidly to accommodate rising demand at home and abroad

PRODUCT CYCLE Product becomes more standardized STAGE 3 Product becomes more standardized Production may move to other developed countries instead of exporting to those countries. Imitating country starts produce by itself instead of importing

Product Cycle Stage 4 and 5 Production has become standardized enough that process moves to developing countries to utilize unskilled labor to lower costs Innovating country becomes importer Innovating country moves production focus to new products and cycle starts over Country where product was developed may begin to import the good from new production country