GRA 6649 International Economics Lecture 8 Associate professor Per Botolf Maurseth 1

Lecture plan

Outline Taking stock –Trade between rich countries –Intra industry trade Increasing returns and monopolistic competition 3

Outline – rest of the course Lecture 8: Increasing returns and monopolistic competition Lecture 9: Increasing returns and monopolistic competition - continued Lecture 10: Economic Geography Lecture 11: Economic Geography Lecture 12: The gravity equation Lecture 13: Open 4

Why is there so much trade between US and other rich countries? Factor content is similar? HOS cannot predict this trade. Much trade is intra-industry, i.e. trade within commodity groups. Standard measure of IIT: The Grubel-Lloyd index G i = 2 min (EXP i, IMP i )/ (EXP i + IMP i ) or G i = 1 – |(EXP i - IMP i )|/ (EXP i + IMP i ) for sector i. A related measure is the net export ratio B i = (EXP i - IMP i )/ (EXP i + IMP i ) since G i = 1 - |B i | 5

G = 1 –  i |(EXP i - IMP i )|/  i (EXP i + IMP i ) The index can be applied to a country’s trade with all partners, or bilaterally. It will normally lower in the latter case. For example, assume that Norway exports good X to Germany and imports it from France. If IIT is calculated for Norway’s total trade in X (with all partners), trade with Germany and France would, taken together, represent intra-industry trade, whereas in bilateral IIT measures it would not. 6

Some stylised facts on IIT: It varies across sectors, and is higher for skill-intensive sectors. It is not positively correlated with measures of economies of scale in production (some results show a negative correlation). It is higher in the trade of rich countries, and between rich countries. It is higher between countries at similar income levels. It falls with the distance between countries. For many EU countries, more than 60% of trade is IIT. Norway has low IIT, around 1/3 (based on 8-digit HS). Oligopoly/concentration: Mixed results as to whether IIT is higher in sectors with high concentration. 7

Trade is intra-industry:

Increasing returns and monopolistic competition Increasing returns: cannot have perfect competition Monopolistic competition –Many varieties within a commodity group –Consumers have preferences for more commodities (an approximation – could be many different consumers as well). –Increasing returns: AC>MC –Free entry ensures zero profits 11

Monopolistic competition Must put emphasis on consumers. This lecture: Dixit-Stiglitz preferences. Autarky market Next time: –Trade –Trade with transportation costs – home market effect 12

Literature: Lecture notes by Karen Helene Ulltveit- Moe. Lecture notes Krugman (1994) ch. 1 and 2 Feenstra (2004) ch. 5 13