The “New Trade Theory”
+ some other post-HO-models
Appleyard & Field (& Cobb): Chapter 10
Krugman & Obstfeld: Chapter 6
Today’s Lecture
1. Economies of scale and the Krugman model
2. Some other post-HO-models
1.
2.
3.
4.
5.
Imitation Lag
The Product Cycle Theory
Gravity Models
New Economic Geography
Heterogeneous Firms
2
The “Krugman Model”: Assumptions
1.
2.
3.
4.
5.
6.
Internal economies of scale
Monopolistic competition
(non-homogeneous goods)
One factor of production (labour)
Identical preferences
Large number of goods produced with the
same technology
Full employment
Paul R. Krugman (1979): Increasing returns, monopolistic competition, and
international trade. Journal of International Economics, Vol. 9(4): 469-479
3
Key assumption 1: Economies of Scale
• External: cost per unit depends on the size of the
industry, not the firm (Silicon Valley, Hollywood...)
• Internal: cost per unit depends on the size of the
firm, not industry (Nokia, Phillips, GE...)
o
o
Krugman models technology as
L = a + b*Q  Q = 1/b*L – a/b
the amount of labour required (L) to produce amount
of input (Q) depends on b and constant a (fixed cost)
→ Doubling the inputs more than doubles the
output (increasing internal economies of scale)
4
Production Possibilities Frontier with
Economies of Scale
Good Y
Good X
5
Key assumption 2:
Monopolistic Competition
• Each firm produces a different brand of the
good (goods that are not exactly the same, but that are
substitutes for one another)
• Each firm takes prices of rivals as given (=no
strategic pricing)
→ Each firm behaves as if it were a monopolist
• However, we assume easy entry and exit →
zero-profits in the long run
o
as long as (average cost < price) more firms enter the
market
6
Long-Run Market Equilibrium of
Monopolistically Competitive Market
The more firms there are:
1. the less each firm
produces → higher
average cost (due to
increasing returns to scale)
→ upward sloping cost
curve
2. the harder the
competition → decreasing
price → downward
sloping price curve
Price
AC
p*
P
n*
Number of firms
7
Introducing Trade to the Monopolistic
Competition Model
• Trade increases market size
→ firms exploit more of the
returns to scale → average cost
decreases → price decreases →
number of firms increases
• i.e. a larger variety of products
is available for smaller price
• everybody are better off even if
the countries are identical
Price
ACA
ACFT
pA
pFT
P
nA
nFT
Number of firms
8
Intra- and Inter-industry Trade
• Inter-industry trade: countries export goods of one
product category and imports goods of other product
category as in the Ricardian and the HeckscherOhlin models
o
Basis for trade: Comparative Advantage due to
differences in productivity (Ricardian model) or
in factor endowments (HO-model)
• Intra-industry trade: countries export and import
products of the same products category as in the
Krugman model
o
Basis for trade: Internal economies of scale
9
Impact of Trade
• Ricardian Model
o complete specialization (linear PPF)
o increase of country’s consumption possibilities
• Heckscher-Ohlin Model
o shift of production towards commodity that uses
intensively country’s abundant factor of production
o real income of the abundant factor increases and the
real income of scarce factor decrease
o increase of country’s consumption possibilities
• Krugman Model
o more firms and more varieties of goods
o lower cost of production → lower price
10
The “integrated” framework
• integrating HO-style and ”Krugman” style models
o
o
endowment-based comparative advantage +
horizontal product differentiation and increasing returns
to scale
• allows for technology differences, factor price
inequality, and trade costs
• Something of a current standard paradigm
Helpman, Elhanan, and Paul Krugman (1985): Market Structure and Foreign Trade: Increasing
Returns, Imperfect Competition and the International Economy. Cambridge, MA: MIT Press.
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Other Explanations of Intra-Industry Trade
• Transport costs in large countries (e.g. a buyer in Maine
buys the Canadian rather than the Californian product)
• Dynamic economies of scale: product differentiation +
learning-by-doing
• Problems with statistics
o
Aggregation: the categories are too wide (e.g. “beverages
and tobacco”)
o
Different quality of goods inside a product category
12
Imitation Lag
• Assume that it takes time for new technology to spread
• Imitation lag: the time between product’s introduction in
country 1 and appearance of a version of that product
produced in country 2
• Demand lag: time between products appearance in country 1
and its acceptance in country 2
• Net lag: imitation – demand lag
→ Trade focuses on new products
13
The Product Cycle Theory
• The product cycle consists of three stages (new,
maturing, standardized)
1. A new product is introduced in a rich country
o
o
High-income demands, labour-saving production
technique
The firms operate only in the domestic markets and learn
production techniques and consumer responses
2. Maturing product
o Economies of scale start to realize
o Demand in other rich countries starts to emerge
o Part of the production may be shifted to these countries
and they might even start exporting to the original country
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The Product Cycle Theory
3. Standardized
Production, consumption
(in the developed country)
product
o
o
Consumption1
exports
imports
Product is well know
to consumers and
producer
Production may shift
to the developing
counties
Vernon (1966): International Investment
And International Trade in the Product
Cycle. Quarterly Journal of Economics 80(2).
Production1
new product
stage
maturing
product
stage
time
standardized
product
15
stage
Gravity Models
• Focus to explain the volume of trade between
countries
• Popular framework in empirical work: Typically the
volume of exports and imports is modelled as a
function of countries national incomes, distance and
other observable characteristics such as population size
and institutional dummies (e.g. free trade area)
16
New Economic Geography
• Firms decide the location of production in the
presence of
o
o
economies of scale → rationale for concentrating
production, imperfect competition
transportation cost → rationale for decentralizing
production
• Dynamic comparative advantage may be based on
coincidence that has set off a cumulative process
• Trade may take place as a result of “arbitrary
specialization based on increased returns”
• Policies may influence the beginning of such an
cumulative process
P. Krugman (1991): Geography and Trade. MIT Press.
17
Models with Heterogeneous Firms
Melitz (2003, Econometrica) model
• Extension of the “Krugman model”
• firms can enter an industry by paying a fixed entry cost, they
then learn their productivity (profitability) and leave if this is
too low
• There are fixed and variable costs also for exporting → only the
most productive firms export
• reductions in barriers to trade → increase profits of exporters
and reduce the export productivity cutoff → labor demand
within the industry rises → increase in wages → profits of
nonexporter decrease → less productive firms bankrupt
A new source of gains from trade: Increase in productivity
See Bernard, Jensen, Redding and Schott (2007): Firms in International Trade, Journal of
Economic Perspectives, 21(3), 105–130
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