1. Introduction Measuring intra-industry trade Dixit-Stiglitz demand Demand effects; income, price elasticity, and price index Increasing returns to scale Optimal pricing and zero profits Explaining intra-industry trade An alternative interpretation: intermediate goods Conclusions CHAPTER 10; INTRA - INDUSTRY TRADE International Trade & the World Economy;  Charles van Marrewijk

3. Introduction Measuring intra-industry trade Dixit-Stiglitz demand Demand effects; income, price elasticity, and price index Increasing returns to scale Optimal pricing and zero profits Explaining intra-industry trade An alternative interpretation: intermediate goods Conclusions CHAPTER 10; INTRA - INDUSTRY TRADE International Trade & the World Economy;  Charles van Marrewijk

4. Introduction International Trade & the World Economy;  Charles van Marrewijk Avinash Dixit (1944 - )

5. Introduction Measuring intra-industry trade Dixit-Stiglitz demand Demand effects; income, price elasticity, and price index Increasing returns to scale Optimal pricing and zero profits Explaining intra-industry trade An alternative interpretation: intermediate goods Conclusions CHAPTER 10; INTRA - INDUSTRY TRADE International Trade & the World Economy;  Charles van Marrewijk

6. Measuring intra-industry trade (= two-way trade in similar goods) International Trade & the World Economy;  Charles van Marrewijk Use the Grubel-Lloyd (GL) index to measure intra-industry trade:

7. Measuring intra-industry trade International Trade & the World Economy;  Charles van Marrewijk Variations in extent of intra-industry trade

8. Measuring intra-industry trade International Trade & the World Economy;  Charles van Marrewijk Increasing importance of intra-industry trade

9. Introduction Measuring intra-industry trade Dixit-Stiglitz demand Demand effects; income, price elasticity, and price index Increasing returns to scale Optimal pricing and zero profits Explaining intra-industry trade An alternative interpretation: intermediate goods Conclusions CHAPTER 10; INTRA - INDUSTRY TRADE International Trade & the World Economy;  Charles van Marrewijk

10. Dixit-Stiglitz demand International Trade & the World Economy;  Charles van Marrewijk If there are N (= ‘large’) different varieties of manufactures And the utility function is: Then, subject to the budget constraint; the demand for a variety, say j, is: (discussed below) Characteristic is the love-of-variety effect, e.g. if c i = c for all i:

11. Introduction Measuring intra-industry trade Dixit-Stiglitz demand Demand effects; income, price elasticity, and price index Increasing returns to scale Optimal pricing and zero profits Explaining intra-industry trade An alternative interpretation: intermediate goods Conclusions CHAPTER 10; INTRA - INDUSTRY TRADE International Trade & the World Economy;  Charles van Marrewijk

12. Demand effects; income, price elasticity, and price index International Trade & the World Economy;  Charles van Marrewijk Dixit-Stiglitz demand depends on: The income level Iequiproportionally The price charged by the producernegatively A parameter  > 1= price elasticity of demand The price index Ppositively Demand for a variety rises if the general price level P increases; Each producer ignores his own impact on this price level, which is reasonable if N is ‘large’ but not if N is ‘small’ (see next slide)

13. Demand effects; income, price elasticity, and price index International Trade & the World Economy;  Charles van Marrewijk

14. Introduction Measuring intra-industry trade Dixit-Stiglitz demand Demand effects; income, price elasticity, and price index Increasing returns to scale Optimal pricing and zero profits Explaining intra-industry trade An alternative interpretation: intermediate goods Conclusions CHAPTER 10; INTRA - INDUSTRY TRADE International Trade & the World Economy;  Charles van Marrewijk

15. Increasing returns to scale (IRS) International Trade & the World Economy;  Charles van Marrewijk If the production function requires a fixed labor cost f before production starts at variable labor cost m there are IRS:

16. Introduction Measuring intra-industry trade Dixit-Stiglitz demand Demand effects; income, price elasticity, and price index Increasing returns to scale Optimal pricing and zero profits Explaining intra-industry trade An alternative interpretation: intermediate goods Conclusions CHAPTER 10; INTRA - INDUSTRY TRADE International Trade & the World Economy;  Charles van Marrewijk

17. Optimal pricing and zero profits International Trade & the World Economy;  Charles van Marrewijk As a result of IRS each variety is produced by single producer. This producer has market power and charges a monopolistically competitive price (determines the optimal price by MR = MC, taking the prices charged by the other firms [the price index P] as given). Because the price elasticity of demand is constant (equal to the parameter  ) the mark-up over marginal costs charged by the producer is also constant. Firms will enter the market (producing new varieties) if profits are positive; they will exit if profits are negative. The number of varieties N produced is therefore determined by the zero-profit condition. In the Dixit-Stiglitz model the number of varieties N produced is proportional to the size of the economy as measured by the labor force

18. Introduction Measuring intra-industry trade Dixit-Stiglitz demand Demand effects; income, price elasticity, and price index Increasing returns to scale Optimal pricing and zero profits Explaining intra-industry trade An alternative interpretation: intermediate goods Conclusions CHAPTER 10; INTRA - INDUSTRY TRADE International Trade & the World Economy;  Charles van Marrewijk

19. Explaining intra-industry trade

20. Introduction Measuring intra-industry trade Dixit-Stiglitz demand Demand effects; income, price elasticity, and price index Increasing returns to scale Optimal pricing and zero profits Explaining intra-industry trade An alternative interpretation: intermediate goods Conclusions CHAPTER 10; INTRA - INDUSTRY TRADE International Trade & the World Economy;  Charles van Marrewijk

21. An alternative interpretation: intermediate goods; Krugman International Trade & the World Economy;  Charles van Marrewijk

22. An alternative interpretation: intermediate goods; Ethier International Trade & the World Economy;  Charles van Marrewijk

23. Introduction Measuring intra-industry trade Dixit-Stiglitz demand Demand effects; income, price elasticity, and price index Increasing returns to scale Optimal pricing and zero profits Explaining intra-industry trade An alternative interpretation: intermediate goods Conclusions CHAPTER 10; INTRA - INDUSTRY TRADE International Trade & the World Economy;  Charles van Marrewijk

24. Conclusions International Trade & the World Economy;  Charles van Marrewijk Empirically observed prevalence of intra-industry trade (two-way trade in similar products) puzzled theorists. Intra-industry trade is measured using the Grubel-Lloyd index. Krugman uses Dixit-Stiglitz variety approach with monopolistic competition and IRS to explain intra-industry trade. Trade extends the market and raises welfare through an increases of the number of varieties available (love-of-variety). Alternative interpretation (Ethier) explains intra-industry trade through exchange of intermediate goods; increased specialization leads to positive production externalities.