Imperfect competition
in international trade
Imperfect competition
in international trade
Edited by
Winston
w. Chang
Department of Economics
Stale University of New York at Buffalo
Buffalo, New York
Seiichi Katayama
Research Institute for Economics and Business Administration
Kobe University
Japan
Springer Science+Business Media, LLC
Library 01 Congress Cataloging-in-Publication Data
Imperlect competition in international tradeledited by
Winston W. Chang,
Seiichi Katayama.
p.
cm.
Includes bibliographical relerences.
ISBN 978-1-4613-5947-0
ISBN 978-1-4615-2249-2 (eBook)
DOI 10.1007/978-1-4615-2249-2
1. Competition, Imperlect. 2. International trade.
3. Commercial policy.
Chang, Winston W.
11. Katayama, Seiichi, 1943HF1414.1458 1994
382'.3-dc20
94-45358
CIP
Copyright © 1995 by Springer Science+Business Media New York
Originally published by Kluwer Academic Publishers in 2001
Softcover reprint 01 the hardcover 1st edition 2001
All rights reserved. No part 01 this publication may be reproduced,
stored in a retrieval system or transmitted in any lorm or by any
means, mechanical, photo-copying, recording, or otherwise, without the
prior writlen permission 01 the publisher.
Springer Science+Business Media, LLC.
Printed on acid-free paper.
Contents
Contributing authors
vii
Preface
ix
1
Introduction
Winston W. Chang and Seiichi Katayama
I
Basic issues of imperfect competition in international trade
2
Theory and policy of trade with imperfect competition
Winston W. Chang and Seiichi Katayama
3
The gains from free trade under imperfect competition
Murray C. Kemp and Masayuki Okawa
4
On the behavior of monopoly in general equilibrium trade models
Makoto Tawada and Masayuki Okawa
5
The international diffusion of the fruits of technical progress under
imperfect competition
Murray C. Kemp and Masayuki Okawa
II
Trade policy issues
13
15
53
63
79
99
6
Demand behavior and import policy
Ronald W. Jones
101
7
Elimination of firm and welfare under international oligopoly
Sajal Lahiri and Yoshiyasu Ono
109
v
vi
CONTENTS
8
Intermediate input dependency, technology catch-up, and
strategic Trade Policy
Winston W. Chang and Ki-Hong Park
9
Tariff protection, imperfect competition, and time consistency
Suezo Ishizawa
10
Imperfect competition, intra-industry trade, and trade policy
Yasuo Uekawa
11
Dynamic effects of subsidies on output and R&D in an international
export rivalry model
Takao Ohkawa and Koji Shimomura
III
Trade liberalization and structural issues
12
Endogenous dualistic structure, Marshallian externalities, and
industrialization
Michihiro Ohyama and Yoshihiko Fukushima
13
Intercountry gaps in increasing-returns-to-scale technologies and the
choice among international economic regimes
Katsuhiko Suzuki
14
Retaliatory mechanisms for eliminating trade barriers: aggressive
unilateralism vs. GAD cooperation
Kathryn E. Spier and David E. Weinstein
15
The impact of EC92 on the third country: a simple analytical
framework under imperfect competition
Junichi Goto
Index
121
143
159
175
185
187
207
231
249
267
Contributing Authors
Winston W. Chang
State University of New York at Buffalo
Yoshihiko Fukushima
University of Stockholm and Keio University
Junichi Goto
Kobe University
Suezo Ishizawa
Tezukayama University
Ronald W. Jones
University of Rochester
Seiichi Katayama
Kobe University
Murray C. Kemp
University of New South Wales
Sajal Lahiri
University of Essex
Masayuki Okawa
Aichi University
Takao Ohkawa
Seinan-Gakuin University
Michihiro Ohyama
Keio University
Vlll
CONTRIBUTING AUTHORS
Yoshiyasu Ono
Osaka University
Ki.Hong Park
Korea Institute for Industrial Economics and Trade, Seoul
Koji Shimomura
Kobe University
Kathryn E. Spier
Northwestern University
Katsuhiko Suzuki
Kwansei Gakuin University
Makoto Tawada
Nagoya City University
Yasuo Uekawa
Nagasaki Prefectural University
David E. Weinstein
Harvard University
Preface
The focus of research in international trade theory has shifted from
models of perfect competition and constant returns to scale to models of
imperfect competition, scale economies, and strategic behavior. The
formal modeling of trade based on increasing returns to scale has
developed slowly, primarily because of the difficulty in specifying a
market structure consistent with the firm's internal scale economies.
Many tractable models of alternative market structures developed by
microeconomic theorists in the mid-1970s have now been applied to the
modeling of trade with imperfect competition. Specifically, advancements
in the theory of monopolistic competition have helped with the modeling
of intra-industry trade in differentiated products. Additionally, the
development of game theory has improved the modeling of trade with
strategic behavior. Imperfect competition, strategic behavior, an~ increasing returns to scale have now been successfully integrated into the
core of trade theory, providing a more realistic view of the real-world
economy and yielding exciting new results with important implications for
trade and industrial policies.
This book is a collection of 14 new research papers that are related to
these new elements of trade. The book is divided into three parts. The
first part examines the basic issues of trade with imperfect competition.
The second part examines trade policy, covering issues such as strategic
trade policy in static and dynamic setting!;. The third part explores
various structural issues such as the optimal choice of trade liberalization
policies, the formation of trade blocks, and open dualistic economy
with externalities.
Some chapters of this book were presented at the 1992 Conference on
International Trade sponsored by the Research Institute for Economics
and Business Administration at Kobe University, and some were presented in seminars also sponsored by the Research Institute. We are
grateful to all the reviewers who served as anonymous referees for the
individual pap~rs. We are also grateful to several colleagues at the
ix
x
PREFACE
Research Institute for their encouragement, and especially to the Diector,
Professor Hideki Yoshihara, for his support of the project. Finally, we
wish to thank the Murata Science Foundation, the Rokkodai Foundation,
and the Research Institute for Economics and Business Administration at
Kobe University for their financial support.
w.w.c.
S. K.
Imperfect competition
in international trade
1
INTRODUCTION
Winston W. Chang and Seiichi Katayama
The orthodox theories of trade were developed under the two key
assumptions of perfect competition and constant returns to scale, and the
main trade determinants were found to be differences in technologies and
differ~nces in factor endowments between countries. The classical
Ricardian theory assumes differences in technologies and demonstrates
that a country will export a good whose production is relatively efficient,
gaining a comparative advantage. The neoclassical Heckscher-Ohlin
theory, on the other hand, assumes that countries have identical
technologies but different factor endowments, and demonstrates that a
capital-abundant country will export a good whose production is relatively
capital intensive. The orthodox theories have thus successfully explained
why countries with different technologies or factor endowments exchange
goods produced in different industries. They are, however, hard pressed
to explain the voluminous intra-industry trade between countries with
similar endowments. Such intra-industry trade has been documented by
Grubel and Lloyd (1975) as a major growth component in the postwar
world trade.
In order to explain the phenomenon of intra-industry trade, recent
trade theory has removed the two orthodox assumptions of perfect
competition and constant returns to scale and has emphasized imperfect
1
2
INTRODUCTION
competitiOn and increasing returns to scale. With increasing returns,
a firm's marginal cost is lower than average cost. If the firm faces a
perfectly competitive market, it must set its product price to marginal
cost and will incur losses. Thus, increasing returns to scale are incompatible with perfect competition and are likely to produce a natural
monopoly. In a world with free trade, a product is therefore likely to
be monopolized by a single producer in one country, and trade will
occur as a result of specialization caused by increasing returns to scale.
This determinant of trade has long been recognized by Graham (1923)
and Ohlin (1924). Moreover, if the products in an industry are differentiated and each variety is produced under increasing returns to scale, a
country may produce a subset of the products, and gainful intra-industry
trade between countries may take place. Although these ideas are
intuitively clear, the development of new trade theory with monopolistic competition was delayed due to a lack of tractable mathematical models based on a market structure that exhibits scale economies
internal to firms. The major breakthrough followed the development of
monopolistic competition modeling by Lancaster (1975), Spence (1976),
Dixit and Stiglitz (1977), and Salop (1979) when Krugman (1979) and
Lancaster (1979) independently developed the new theory of trade under
monopolistic competition.
Krugman adopts Dixit-Stiglitz's love-of-variety approach, which
reflects individuals' desire for variety in consumption. Lancaster, on the
other hand, pursues the ideal-variety approach that allows heterogeneous
households to be distinguished by their most preferred set of product
characteristics. The extent of diversity provided by the market is limited
by increasing returns to scale in production. Each variety is monopolized
by a firm in a monopolistic market. Intra-industry trade between similarly
endowed countries will then take place. Gains from trade can be realized,
since trade expands the size of the market and causes a greater variety of
goods to be produced. The original models of Krugman and Lancaster
both assume a single tradeable goods sector and identical countries.
There have since been many extensions of their models in the literature.
Krugman (1980) further introduced transportation costs and different
taste patterns and showed that countries develop competitive advantage
in goods that have heavy demand at home. Further extensions by Dixit
and Norman (1980), Lancaster (1980), Helpman (1981), and Krugman
(1981) introduced a second sector in a general equilibrium framework and
assumed different factor endowments or sectoral productivities between
countries. Ethier (1979) introduced international returns to scale as a new
determinant of trade by showing that scale economies resulting from an
INTRODUCTION
3
increased division of labor rather than plant size will at the aggregate
level depend upon the size of the world market. He showed that such
international returns to scale imply a theory of intra-industry trade.
Ethier (1982) further extended his model of differentiated producer goods
to establish the relations between international returns to scale, the traditional national returns to scale, and the factor-endowments theory of
trade. These extensions successfully integrate the traditional theory of
interindustry trade based on comparative advantage and the new theory
of intra-industry trade based on scale economies.
Intra-industry trade has been shown to arise even in identical products.
When a market is imperfectly competitive with oligopolistic structure,
firms located in different countries may penetrate one another's local
markets. Brander (1981) showed that if firms producing identical products
behave like Cournot competitors and if transport costs are not too
high, then cross-hauling or two-way trade can take place. Brander and
Krugman (1983) further extended the original Brander contribution to
include arbitrary demand conditions. They established that two-way
trade is possible when firms perceive each local market as distinct,
independently supplying quantities to each of them. Markusen (1981), by
assuming that countries are identical in size and factor endowments and
that firms have identical technologies, instead treated the world as a
single integrated market and showed that there are still gains from world
competition even though there is no world trade in equilibrium.
The new trade theory with imperfect competition has produced diverse
normative implications for trade policy, drawn chiefly from a non-firstbest environment in which the traditional first-best case with perfect
competition is no longer assumed. The new policy implications are quite
sensitive to different factors such as the number of firms in the industry,
the form of oligopolistic competition, an integrated or segmented market,
and the potential for free entry. Free trade promotes worldwide competition and efficient resource allocation. It can serve to tame domestic
monopoly power and reduce the noncompetitive practices of firms. Thus,
free trade has been shown to be an optimal policy unless a country
is large enough to influence the terms of trade. However, recent
work in strategic trade theory has incorporated imperfect competition,
demonstrating that there are cases for national governments to help local
firms against foreign rivals. For example, Brander and Spencer (1985)
showed that national welfare can be increased by the use of export
subsidy to shift profit from a foreign firm to the domestic firm when both
firms are Cournot competitors in a segmented, third-country market.
Eaton and Grossman (1986) found that if instead the firms are Bertrand
4
INTRODUCTION
competitors, then an export tax rather than an export subsidy raises
national welfare.
There are a number of important surveys and studies that provide
more detailed and systematic accounts of the recent advances in trade
theory with increasing returns to scale. (See, for example, Helpman and
Krugman (1989), Krugman (1990), and Vousden (1990).) Grossman
(1992) has additionally selected many important papers in a collected
reading. For the current state of research on the empirical evidence, see
Krugman and Smith (1994) and also the survey article by Krugman (1994).
This book develops and reviews the recent advances in trade theory
with the features of increasing returns to scale and imperfect competition.
The integration of these features into the new theory has provided a more
realistic view of the real-world economy and also yielded new implications for trade policy. A number of chapters examine new theoretical
issues in trade, some extend and clarify the existing literature, and some
apply new models to analyze policy issues.
The book is organized into three parts. The first part covers the broad
and basic trade issues that arise under imperfect competition. The second
part examines policy issues, including strategic trade policy in static and
dynamic settings. The third part deals with issues such as the optimal
choice of trade liberalization policies, the formation of trade blocks, and
open dualistic economy with externalities.
Chang and Katayama (chapter 2) critically survey recent developments in the theory of trade with imperfect competition. Imperfect
competition can arise from factors such as the presence of increasing
returns to scale, entry barriers, and product differentiation. With the new
modeling approaches, the new trade theory has incorporated many new
features of imperfect competition, including differentiated products,
strategic behavior of firms, endogenous market structure, and the free
entry and exit of firms. As a result, the new theory has produced many
new theoretical findings and seemingly inconsistent policy implications.
There is clearly a need to systematize and integrate the array of models
and results. This chapter delineates the key features of the new theory
and integrates the diverse models into a more coherent framework. The
main part of this chapter is organized by the industry structure covering
monopoly, oligopoly, and monopolistic competition. Since quality differentiation is an important source of the market power, this chapter also
discusses its implications for trade theory and policy.
Kemp and Okawa (chapter 3) consider the basic and traditional
problem of gains from trade under imperfect competition. Though there
exist some results in the literature on this problem (see, for example,
INTRODUCTION
5
Helpman and Krugman (1985, pp. 96-100)), gains from trade have yet to
be related to such underlying characteristics of the economy as national
endowments, preferences, technologies, and market structures. In this
chapter, a world economy is assumed to consist of national economies
that differ only in scale. Under the conventional perfect-competition
assumption, all countries would have the same set of autarkic equilibria,
and there would be no international trade and hence no gains from trade.
However, it is shown that the opportunity to trade would be gainful if
there is a single oligopolistic industry. They further show that such a
conclusion does not generalize if an additional imperfectly competitive
industry is introduced. These results are explained in light of the number
of distortions in the economy and the theory of second best. When there
is only one distortion, a reduction in it is potentially beneficial, but when
there are two or more distortions, such a reduction is not necessarily
beneficial, even potentially.
In chapter 4, Tawada and Okawa reexamine three existing trade
models of monopoly that consider often-neglected problems in the
analysis of a monopoly in general equilibrium (Melvin and Warne (1973),
Markusen (1981), and Cassing (1977)). One such problem is the income
effect on the demand for a commodity produced by a monopolist, and
the other is the factor price effect. Both effects may be crucial to the
equilibrium outcome with a monopoly. In the general equilibrium "model,
national income must be taken into account. It is rational for the
monopolist to choose the level of the commodity price by considering
both the indirect effect on demand through national income and the
direct effect of the price on demand. When a monopoly has also a
monopsony power in the factor markets, the equilibrium outcome in the
general equilibrium model is further complicated by this factor. The
authors in this chapter focus mainly on the effect of income on demand
and obtain some new results on the optimal conditions of a monopoly in
the aforementioned three models of trade. It is shown that the income
effect has very different implications for equilibrium outcome, depending
crucially upon the model specification, firms' behavior, and whether or
not the monoplist also has a monopsony power.
Kemp and Okawa in chapter 5 focus on technology and trade. As an
explanation for trade, many theories have focused on the existence of
cross-country differences in technologies. A natural problem in this
context is whether or not technical progress occurring in one country
benefits the other countries. Hicks (1953) and Ikema (1969) have shown
that in a two-country world with no joint production and costant returns
to scale, a uniform Hicksian technical progress in one country necessarily
6
INTRODUCTION
benefits the other if the preferences in the progressive country are
homothetic and if initially there is some international trade. Although the
robustness of the Hicks- Ikema proposition has been examined in models
that allow produced inputs, international capital mobility, and joint
production, these models have been restricted to a competitive industrial
structure. Kemp and Okawa reconsider the proposition in a different
industrial structure. They assume that one of the two industries is
oligopolistic and show that the proposition still holds under a simple
additional restriction on the elasticity of substitution in consumption.
Jones in chapter 6 reconsiders the Brander and Spencer (1984) model
in a general equilibrium framework. Brander and Spencer in a partial
equilibrium model find that an import subsidy, not tariff, may be optimal
for a country facing a foreign-monopoly supplier. This contrasts with the
traditional result that a country large enough to influence the world price
can raise its national welfare by levying an import traiff. Jones finds that a
trade tax or subsidy involving a movement along a domestic demand
curve is perceived as a shift in demand based on the price received by the
foreign supplier; the optimal trade policy therefore hinges on the shapes
of the import demand curve. He shows that the Brander-Spencer result
holds if the import demand elasticity is negatively related to price, but
that it no longer holds if the elasticity of substitution is constant.
In chapter 7, Lahiri and Ono examine the implications for national
welfare in an export-rivalry model when one of the two home firms is
eliminated. In the original Bander and Spencer model (1985), there are
two producing countries, each with one firm competing in a market in the
third country. Lahiri and Ono consider a more general model by allowing
one of the producing countries to have a second firm with a different cost
structure. They examine the effects on all three countries' welfare when
this second firm is eliminated. They find that such an elimination makes
the other producing country better off and the consuming country worse
off. The country that eliminates a firm will benefit if that firm's share in
the country's exports is less than a certain critical value. Lahiri and Ono
also show that if the demand function is linear, this critical share value is
significantly higher than the one for the closed-economy case examined in
Lahiri and Ono (1988).
Chang and Park in chapter 8 examine the strategic trade policy in a
market structure that exhibits vertical linkage in intermediate inputs. A
monopolist often controls the production of an essential intermediate
input necessary for the production of a final good. Such a vertically
integrated firm often exports the input to other downstream firms abroad,
allowing them to use it to produce the final good. Chang and Park
INTRODUCfION
7
analyze a model of export rivalry in which a downstream firm relies on
the supply of an input from a vertically integrated upstream firm in
another country. Both firms produce a homogeneous final good for
export to the world market. The upstream firm chooses between vertical
supply and vertical foreclosure. If it chooses the former, the downstream
firm will have the opportunity to learn to produce the final good in a later
period. This chapter analyzes the optimal strategic behavior of each firm
and the optimal trade policy in the single- and multiperiod cases.
Specifically, the possibility of technology catch-up in the multiperiod case
is considered, and the implications for the dynamic endogenous market
structure are examined.
Ishizawa (chapter 9) reexamines the Brander and Spencer proposition
that an import subsidy could be optimal in the presence of a foreign
monopoly. He considers a model in which production takes one period
of time. The foreign monopolist makes its production decision at the
beginning of the period and exports its product at the end of the period.
The home country's government announces its import tariff before foreign
production takes place. Ishizawa shows that if the monopolist's decision is
irreversible and if there is no preestablished trade policy by the home
government, then a time-consistent optimal trade policy always calls for
a tariff. He also shows that the welfare of the domestic economy is
lower under a time-consistent import tariff than under a traditional
optimal tariff.
In chapter 10, Uekawa examines a duopoly model of intra-industry
trade in a two-good general equilibrium model. One good is produced by
perfectly competitive firms. The other good, which is traded intraindustrially, is produced both by a home firm and a foreign firm: they are
assumed to have nonlinear cost functions and to be Cournot competitors.
In addition to import tariff, Uekawa allows export subsidy to be another
trade policy instrument. The considerations of a general cost structure
and dual policy instruments yield many new results in this model.
Uekawa derives the conditions for the uniqueness of solution for a given
tariff and subsidy structure. He examines the effects of imposing an
import tariff and an export subsidy by the home country on the production, consumption, and trade volume of the intra-industrially traded
good. He also examines the implications of these policies on the national
and world welfare. Factors such as the duopoly's relative costs and the
strategic substitutability or complementarity between the sales of the two
firms are shown to be crucial in determining the policy effects.
Ohkawa and Shimomura (chapter 11) extend the Spencer and Brander
model (1983) of an international duopoly into a dynamic framework. They
8
INTRODUCfION
use the differential game approach and analyze the short-run and longrun effects of an R&D subsidy by the home country on both the home
and foreign firms' outputs and on their R&D outlays. In the Spencer and
Brander model, it is assumed that a firm makes its R&D investment and
enters production only once. But Ohkawa and Shimomura introduce the
adjustment cost of R&D investment and construct a firm's decision model
with an infinite horizon. They derive the open-loop Nash equilibrium
solution and show that if Spencer and Brander's assumptions on the profit
function are imposed in the present model, the short-run and long-run
effects of a change in the R&D subsidy on the firm's outputs and its R&D
investments are virtually the same as those derived in the static model.
Ohyama and Fukushima in chapter 12 develop a model of an open,
dualistic economy with intersectoral wage differentials determined
endogenously by labor-management bargaining in the industrial sector.
As is well known in the Harris-Todaro (1970) type of model, one of the
shortcomings in the development literature is the assumption that the
minimum wage rate is exogenously given. Ohyama and Fukushima
introduce bargaining between the labor union and the producer of
the industrial sector to determine the wage rate. They also introduce
Marshallian externalities in this sector. It is shown that the bargaining
equilibrium will result in urban unemployment if and only if the labor
union has a positive bargaining power. Furthermore, subsidization of the
industry having an excess wage is shown to be undesirable so long as
subsidization reflects the union's bargaining power. When the industrial
sector exhibits decreasing returns to scale, a wage subsidy to this sector
will reduce national welfare in the presence of union's bargaining power
unless beneficial industrial externalities are sufficiently strong. On the
other hand, if the industrial sector exhibits increasing returns to scale,
they show that a policy-supported industrialization always improves
national welfare regardless of the union's bargaining power. Ohyama
and Fukushima also consider the potentially negative effect of the
terms-of-trade change on the welfare of the economy.
In chapter 13, Suzuki compares levels of national welfare among a
number of international economic regimes. Much effort has been directed
recently by leading industrial countries towards liberalizing trade in goods
and capital, but not towards promoting labor migration. This chapter
examines the rationality of such policy asymmetry under four different
international economic regimes: free trade in goods only, free trade in
goods and free mobility of capital, free trade in goods and free mobility
of labor, and free trade in goods and free mobility in capital and labor.
Suzuki examines a two-country, two-factor general equilibrium model
INTRODUCfION
9
in which intra-industry trade takes place in differentiated products.
Monopolistic competition rules the market, and increasing returns to
scale prevail in production. Capital is a fixed input and labor a variable
one. Suzuki derives the conditions for ranking the various international
economic regimes and explains the rationale of the aforementioned policy
bias. He shows that a regime that is one country's best choice is likely to
be the other country's best choice as well. Specifically, if the capitalabundant country is technologically superior and the labor-abundant
country is technologically inferior, then the mutual choice of the most
preferred regime is likely to be free trade in good and free labor mobility.
This result depends crucially upon the assumption that capital is a fixed
and labor a variable input in the production of the differentiated goods. If
this assumption is reversed, the preceding mutual choice is likely to be
changed to free trade in goods and capital as the most preferred regime.
The ranking of the regimes is shown to depend also on the countries'
relative factor endowments and relative technological superiority.
In chapter 14, Spier and Weinstein examine the welfare effects of
various retaliatory mechanisms when there are nontariff barriers that
cannot be perfectly observed. In their model, countries choose their
nontariff barriers and punitive tariffs to maximize national welfare in the
non-cooperative case. There are four-stage games. In stage 1, countries
simultaneously threaten to impose retaliatory tariffs once they detect a
positive signal of a nontariff barrier erected by their trading partner.
In stage 2, the countries simultaneously choose the optimal levels of
nontariff barriers. In stage 3, retaliatory tariffs are actually imposed upon
observing signals. In stage 4, the firms in both countries simultaneously
choose quantities in the two markets. Spier and Weinstein find that when
only one country retaliates in response to foreign barriers, national
welfare is higher than without retaliation, but that free trade cannot be
achieved in this unilateralism case. In the case of proliferated unilateralism
in which both countries retaliate against each other, they find that there
exists a unique symmetric subgame perfect Nash equilibrium in which
both countries never impose nontariff barriers. Proliferated unilateralism
yields a higher world welfare because each country's retaliatory mechanism deters cheating. However, the noncooperative choice of retaliatory
tariffs is shown to be excessive in punishing detected barriers as compared
with the case of cooperative choice. Thus, the GATT Cooperation is
shown to yield the highest welfare among the three mechanisms.
In chapter 15, Goto analyzes the effects of a regional economic
integration on the economy of an outside nonmember country. There
have been numerous works in the literature about the impact of a
10
INTRODUCTION
regional economic integration on its member countries. Smith and
Venables (1988) and Gasiorek, Smith, and Venables (1992) have
examined the impact on the member countries of the completion of the
internal market in the European Community (EC). However, there are
no major studies that analyze the impact of European integration on
outside countries such as Japan. This chapter fills the gap by analyzing the
impact of EC92 on Japan. Goto presents a simple computable general
equilibrium model with imperfect competition. To account for the importance of intra-industry trade in manufacturing goods, he incorporates
increasing returns to scale and product differentiation into the model.
Special functional forms are used so that calibration can be made with a
given set of parameter values. He shows that the formation of the EC
theoretically reduced Japan's welfare, worsened Japan's terms of trade,
diverted trade away from Japan, and created trade among the
EC members.
Recent developments in the theory and policy of trade have boosted
increasing returns to scale and product differentiation to a prominent
role. The current literature has succeeded in developing models with
intra-industry trade in imperfectly competitive markets. Firms are
assumed to possess some market power and often to be in an environment of strategic competition. In such a situation, active governmental
policies may be called for in order to maximize a country's welfare. Since
the policy prescriptions are often extremely sensitive to factors such as
model specifications, firms' strategies, and market structures, the new
theory has opened the way for a wide range of topics for further inquiries
and applications.
References
Brander, J. A. (1981), Intra-industry trade in identical commodities, Journal of
International Economics 11,1-14.
Brander, J. A. and P. R. Krugman (1983), A "reciprocal dumping" model of
international trade, Journal of International Economics 15, 313-23.
Brander, J. A. and B. J. Spencer (1984), Trade warfare: tariffs and cartels,
Journal of International Economics 16,227-42.
Brander, J. A. and B. J. Spencer (1985), Export subsidies and international
market share rivalry, Journal of International Economics 118, 83-100.
Cassing, J. (1977), International trade in the presence of pure monopoly in the
non-traded goods sector, Economic Journal 187, 523-32.
Dixit, A. K. and J. E. Stiglitz (1977), Monopolistic competition and optimum
product diversity, American Economic Review 167, 297-308.