1. International Economics
Lecture 6 | Carlos Cuerpo | Scale, Competition and Trade

2. Scale, competition and trade: Motivation
The observed importance of intra-industry trade:
Traditional Trade Theory is no longer able to explain these patterns
Exports and Imports within sectors exhibit a tendency towards equalization rather than national specialization
Grubel-Lloyd index indicates the relative importance of inter (tends to 0) vs. intra-industry (tends to 1) trade
A new Trade Theory was needed to explain why similiar countries (in terms of technology, endowments,…) gain from trading with each other and why a significant part of that trade is made within the same industries.
Intra-Industry Trade: Balassa (1966) showed that the trade share of the dominant suppliers in an industry during the implementation of the EEC decreased in practically all industries
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3. Scale, competition and trade: basic assumptions
Economies of Scale:
Figure 1. Unit Cost of Production
Increasing Returns to Scale: Output grows proportionately more than the increase in inputs.
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Source: WTO World Trade Report 2008

4. Scale, competition and trade: basic assumptions
Economies of Scale:
Common inreal-life situations: Existence of fixed costs, that get distributed over a larger number of units, as the output level increases.
IRS result in Production Frontiers that are CONVEX
Increasing Returns to Scale: Output grows proportionately more than the increase in inputs. Y B’
Pre-Trade Equilibrium: A. With identical technology, endowment and preferences.
Trade allows complete specialization [B, B’]
If we allow a 1 to 1 exchange ratio, we reach a higher indifference curve.
Pattern of Trade is not determined: Historical accidents
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5. Scale, competition and trade: basic assumptions
Product Differentiation:
We do not observe complete specialization because consumers prefer to choose from differen variaties: 'love of variety'
This leads to Intra-Industry Trade, which arises to take advantage of economies of scale in production.
Intra-industry trade benefits consumers because of the wider range of choices available, and the lower prices due to Ec of Scale.
Both types of trade (inter and intra-industry) occur today and are backed by different theories.
Differentiated Products: The somewhat different products produced by different manufacturers in the same industry
International competition forces each firm in industrial countries to produce just a few varieties and styles of the same product in order to keep unit costs low.
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6. Scale, competition and trade: Assignment
Evaluate the relative importance of economies of scale and comparative advantage incausing the following:
Most semiconductors are manufactured in either the US or Japan.
Most of the world's aluminium is smelted in Norway or Canada.
Much of the world's best wine comes from France.
Half of the world's large jet aircraft is assembles in Seattle.
Most Scotch whiskey comes from Scotland
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