Download - Lectures 4 and 5 Modern Trade Theories
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Modern Trade Theories
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Introduction
• Technology Theories of Trade– Imitation lag hypothesis– Product cycle theory
• Economies of Scale and Trade
• Intra industry trade– Product differentiation, monopolistic
competition & intra industry trade– Oligopoly & intra industry trade– Linder’s Demand-based Theory
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Imitation Lag HypothesisPosner 1961
• Same technology not available in all countries.
• R&D results in new product in Country A.• Demand lag before consumers in country B
want to buy.• Imitation lag before firms in country B start to
produce.• During net lag (i.e. imitation lag - demand lag)
country A can export to Country B without competition.
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Product Life Cycle TheoryVernon 1966
3 stages of product life-cycle:
• New Product Stage– produced & consumed only in home country
• Maturing Product Stage– standardisation of production & exports to other
high-income countries
• Standardised product Stage– production may shift to LDCs with lower labour
costs
Theory of dynamic comparative advantage
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Product Life Cycle TheoryVernon 1966
Production/Consumptionof product
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Economies of Scale External to Firm
H0
Q0
AC ACi Aci(Q0)
H0=F0
q0
qiQi
Industry level Firm level
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Economies of Scale External to Firm
H0
H1
Q0 Q1
AC ACi Aci(Q0)
Aci(Q1)
H0=F0
H1
q0
qiQi
Industry level Firm level
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Economies of Scale External to Firm
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Internal Economies of Scale: Monopoly
APH
E
MC
AC
DH
C
qH MR q0
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Internal Economies of Scale: Monopoly
APHE
MCAC
C
qH MRH
qW
DH=MRH+FDH+F
B
FG
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Internal Economies of Scale: Monopoly
APHE
MCAC
C
qH MRH
qW
DH=MRH+FDH+F
B
FG
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Intra Industry Trade
• What is intra industry trade?
• The aggregation problem
• Why does intra industry trade occur?
• Product differentiation, monopolistic competition & intra industry trade
• Oligopoly & intra industry trade
• Linder’s demand-based theory
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What is Intra Industry Trade?
Country
Country
Insulin
Bacon
H
F
Inter-industry trade only
Insulin
Bacon
Intra-industry trade only
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What is Intra Industry Trade?
Country
Country
Insulin
Bacon
H
F
Partly inter-industry trade & partly intra-industry trade
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What is Intra Industry Trade?
• Grubel & Lloyd measured intra industry trade as:Bi = (Xi + Mi) - |Xi - Mi| . 100 %
(Xi + Mi)
where (Xi + Mi) is total trade in industry i and |Xi - Mi| is the degree of non-overlap
• Values range from – 0% (no intra industry trade) to – 100% (pure intra industry trade)
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The Aggregation Problem
• Firms are grouped into industries using the SITC (Standard International Trade Classification).
• Controversy centres on 2 issues– industry definition– how much is “substantial” intra industry trade?
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Why does Intra Industry Trade Occur?
• Several minor cases– Entrepot trade– Seasonality– Transport costs
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Transport Costs & IIT
Country A Country B
FA • • CB
CA • • FB
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Why does Intra Industry Trade Occur?
• Several minor cases– Entrepot trade– Seasonality– Transport costs
• Differentiated products – monopolistic competition
• Oligopoly
• Overlapping demand
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Product Differentiation, Monopolistic Competition & IIT
Krugman’s model
• Assume:– identical firms with each firm facing downward
sloping demand curve and differentiated products.
• In a closed economy:No. of firms = Industry demand
Profit max. output of a firm
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Oligopoly & IIT: Reciprocal Dumping (Brander & Krugman 1983)
• Assume 2 countries with identical monopoly producers.
• In fully integrated international market there would be a duopoly.
• In a simple Cournot model, free trade will cause each to increase production, so price will fall
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Oligopoly & IIT: Reciprocal Dumping (Brander & Krugman 1983)
Country H Country F
Producer H Producer F
Consumers Consumers
1 243
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Oligopoly & IIT: Reciprocal Dumping (Brander & Krugman 1983)
• In practice, full market integration doesn’t happen.
• Producer in H will export if:
PF > MC + transport costs
( given market segmentation PH not affected)
• A parallel argument applies to producer in F, who exports if:
PH > MC + transport costs
• So 2-way IIT occurs
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Oligopoly & IIT: Reciprocal Dumping (Brander & Krugman 1983)
PH0
qH0 MRH
DH
MCH
qH
PHPF
PF0
PF1
qF0 qF1
MRF
MRHF
DF
MCF
MCH+TC
Country H Country F
Imports
qF
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Linder’s Demand-based Theory 1961
• Steffan Linder distinguished sharply between:– Trade in primary goods (explained by
Heckscher-Ohlin);– Trade in manufactures (explained by
demand factors).
• Main determinant of demand in a country was income /head. With high income average consumer buys better quality goods.
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Linder’s Demand-based Theory 1961 (continued)• Empirical tests support Linder’s analysis,
but countries with similar per capita incomes are often close geographically.
• Linder doesn’t predict direction of trade flows (could be 2-way).
• Growth of travel & communications since he wrote may have changed factors he stressed.
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Empirical Work
• Typically industrialised countries have a high GL index of 60-80% – (e.g. see Culem & Lundberg 1986)
• Japan is exceptionally low (40-50%)
• Little IIT between industrialised & developing countries
• IIT increases with economic development
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Porter’s DiamondBusiness strategy, market structure & competition
Factors of production
Domestic demand
Suppliers & affiliated companies
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Porter’s Diamond
Business strategy, market structure & competition
Factors of production
Domestic demand
Suppliers & affiliated companies
Government
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Summary
We have looked at various modern theories of international trade
• Technology based theories – from Posner & Vernon
• Economies of scale & trade• Theories on intra industry trade
– Imperfect competition theories from Krugman– Linder’s demand-based theory
• Porter’s Diamond
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Summary
• Trade between industrialised countries can be explained by a combination of comparative & competitive advantage.
• Modern theories can add to our understanding of international trade, but we shouldn’t reject the more traditional theories