1. Chapter 3 Modern Trade Theories
International Economics
Chapter 3
Modern Trade Theories

2. Chapter 3 Modern Trade Thoeries
3.1 Existence of Intraindustry Trade
3.2 Technological gap, Product life Cycle and International Trade
3.3 Theory of Overlapping Demands
3.4 Economies of Scale, Imperfect competition, and International Trade
3.5 Reciprocal Dumping

3. 3.1 Existence of Intraindustry Trade
Advanced industrial countries have increasingly emphasized intraindustry trade —two-way trade in a similar commodity.
Intraindustry trade involves flows of goods with similar factor requirements. countries that are net exporters of manufactured goods embodying sophisticated technology also purchase such goods from other countries.

4. 3.1 Existence of Intraindustry Trade
Intraindustry Trade in the U.S., 2002
( in Billion of Dollars)
Category
Exports
Imports
Motor Vehicles
60.39
168.1
Electrical machinery
82.7
81.2
Office machines
39.7
76.9
Telecommunications equipment
24.9
66.3
Power-generating equipment
34.4
34.0
Industrial machinery
31.8
35.2
Scientific instruments
29.2
20.9
Transportation equipment
46.1
20.2
Chemicals
16.8
30.2
Apparel and clothing
8.0
63.8

5. 3.1 Existence of Intraindustry Trade
Reasons for Intraindustry Trade
Transportation costs
Seasonal
Manufacturers in each country produce for the “majority” consumer tastes within their country while ignoring “minority” consumer tastes
Overlapping demand segments in trading countries
Economies of scale

6. Chapter 3 Modern Trade Thoeries
3.1 Existence of Intraindustry Trade
3.2 Technological gap, Product life Cycle and International Trade
3.3 Theory of Overlapping Demands
3.4 Economies of Scale, Imperfect competition, and International Trade
3.5 Reciprocal Dumping

7. 3.2 Technological Gap, Product Life Cycle and International Trade
Technological gap is a cause of international trade and determines the flow of international trade.

8. 3.2 Technological Gap, Product Life Cycle and International Trade
T0-T1: the stage of demand lag
the time lag from the invention of new products in innovating countries to the acceptance of importing countries.
T0-T3: the stage of imitation lag
the time interval from the invention of new products in innovating countries to generic production until the import is zero.
T0-T2: the stage of response lag
the time lag from the invention of new products to imitation of importing countries.
T2-T3: the stage of grasp lag
from imitation to no import until the generic production can meet domestic demand and turn to export.
T1-T3 is the trading period caused by technological gap.

9. 3.2 Technological Gap, Product Life Cycle and International Trade
The technological gap theory explains the causes of trade among different countries from the perspective of comparative advantage, and proves that leading technology can form comparative advantage even among the countries with close endowments and tastes.
However, the theory hasn’t explained the transfer of trade flow and the causes of the emergence and disappearance of technological gap.

10. 3.2 Technological Gap, Product Life Cycle and International Trade
The life cycle of products means all products will experience the course of innovation, growth, maturity and decline.
The stage of new products
The stage of mature technique
The stage of standardization

11. 3.2 Technological Gap, Product Life Cycle and International Trade
Model of Product Life Cycle

12. 3.2 Technological Gap, Product Life Cycle and International Trade
O- t1
the introduction of new products
t1-t2
the growing period of products
t2-t3
the maturing period of products
t3-t4
The innovating country can manufacture the identical cheaper products than the inventing country by native cheap non-skilled labor, sell in the international market and compete with the inventing country.
After t4
Imitation countries begin to sell products to the inventing country, and the output of the inventing country will decrease so substantially as to come to a full stop. And the life cycle of the products will finish.

13. Chapter 3 Modern Trade Thoeries
3.1 Existence of Intraindustry Trade
3.2 Technological gap, Product life Cycle and International Trade
3.3 Theory of Overlapping Demands
3.4 Economies of Scale, Imperfect competition, and International Trade
3.5 Reciprocal Dumping

14. 3.3 Theory of Overlapping Demands
Wealthy (industrial) countries will likely trade with other wealthy countries, and poor (developing) countries will likely trade with other poor countries. The Linder hypothesis is thus known as the theory of overlapping demands.

15. 3.3 Theory of Overlapping Demands
Linder does not rule out all trade in manufactured goods between wealthy and poor countries.
There will always be some overlapping of demand structures: some people in poor countries are wealthy, and some people in wealthy countries are poor.
However, the potential for trade in manufactured goods is small when the extent of demand overlap is limited.

16. Chapter 3 Modern Trade Thoeries
3.1 Existence of Intraindustry Trade
3.2 Technological gap, Product life Cycle and International Trade
3.3 Theory of Overlapping Demands
3.4 Economies of Scale, Imperfect competition, and International Trade
3.5 Reciprocal Dumping

17. 3.4 Economies of Scale, Imperfect Competition, and International Trade
Many industries are characterized by economies of scale (also referred to as increasing returns), so that the more efficient production is, the larger the scale at which it takes place.

18. 3.4 Economies of Scale, Imperfect Competition, and International Trade
Where there are economies of scale, doubling the inputs to an industry will more than double the industry’s production.
Relationship of Input to Output for a Hypothetical Industry
Output
Total Labor Input
Average Labor Input 5 10 2 15
1.5 20
1.3 25
1.25 30
1.2 35
1.17

19. 3.4 Economies of Scale, Imperfect Competition, and International Trade
Economies of Scale as a Basis for Trade

20. 3.4 Economies of Scale, Imperfect Competition, and International Trade
Economies of scale provide additional cost incentives for specialization in production.
Instead of manufacturing only a few units of each and every product that domestic consumers desire to purchase, a country specializes in the manufacture of large amounts of a limited number of goods and trades for the remaining goods.
Specialization in a few products allows a manufacturer to benefit from longer production runs which lead to decreasing average costs.

21. 3.4 Economies of Scale, Imperfect Competition, and International Trade
Trade and Specialization under Decreasing Costs

22. 3.4 Economies of Scale, Imperfect Competition, and International Trade
As South Korea moves to the right of Point A along its PPF, the relative cost of steel continues to decrease until South Korea totally specializes in steel production at Point C.
Similarly, as the United States moves to the left of Point B along its PPF, the relative cost of computers continues to fall until the United States totally specializes in computers.
Both countries can attain consumption points that are superior to those attained in the absence of trade.

23. 3.4 Economies of Scale, Imperfect Competition, and International Trade
In monopolistic competition models, two key assumptions are made to get around the problem of interdependence.
First, each firm is assumed to be able to differentiate its product from that of its rivals.
Second, each firm is assumed to take the prices charged by its rivals as given.

24. 3.4 Economies of Scale, Imperfect Competition, and International Trade
Equilibrium in Monopolistically Competitive Market

25. 3.4 Economies of Scale, Imperfect Competition, and International Trade
The number of firms in a monopolistically competitive market, and the prices they charge, are determined by two relationships.
On one side, the more firms there are, the more intensely they compete, and hence the lower is the industry price. This relationship is represented by PP.
On the other side, the more firms there are, the less each firm sells and therefore the higher is its average cost. This relationship is represented by CC.
The equilibrium price and number of firms occur when price equals average cost, at the intersection of PP and CC.

26. 3.4 Economies of Scale, Imperfect Competition, and International Trade
Monopolistic Competition and Trade
The number of firms in a monopolistically competitive industry and the prices they charge are affected by the size of the market.
In larger markets there usually will be both more firms and more sales per firm; consumers in a large market will be offered both lower prices and a greater variety of products than consumers in small markets.

27. 3.4 Economies of Scale, Imperfect Competition, and International Trade
An increase in the size of the market allows each firm, given other things equal, to produce more and thus have lower average cost. This is represented by a downward shift from CC1 to CC2.The result is a simultaneous increase in the number of firms (and hence in the variety of goods available) and a fall in the price of each.

28. Chapter 3 Modern Trade Thoeries
3.1 Existence of Intraindustry Trade
3.2 Technological gap, Product life Cycle and International Trade
3.3 Theory of Overlapping Demands
3.4 Economies of Scale, Imperfect competition, and International Trade
3.5 Reciprocal Dumping

29. 3.5 Reciprocal Dumping
In general, the practice of charging different customers different prices is called price discrimination.
The most common form of price discrimination in international trade is dumping, a pricing practice in which a firm charges a lower price for exported goods than it does for the same goods sold domestically.

30. 3.5 Reciprocal Dumping
Each firm has an incentive to “raid” the other market, selling a few units at a price that is lower than the home market price but still above marginal cost.
If both firms do this, however, the result will be the emergence of trade even though there is no initial difference in the price of the good in the two markets and there are some transportation costs.
The situation in which dumping leads to a two-way trade in the same product is known as reciprocal dumping.