1. ECON 321 INTERNATIONAL ECONOMICS
Chapter 6
NEW TRADE THEORIES

2. 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

3. 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

4. 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)

5. 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

6. 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

7. 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

8. 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.

9. 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.

10. 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

11. 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

12. 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

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

14. 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.

15. 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

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

17. 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

20. 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

21. 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.

22. 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.

23. 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.

24. Product Cycle Model.
Four stages of development

25. 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

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

27. 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

28. 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