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International Economics

Chapter 3 Modern Trade Theories

Chapter 3 Modern Trade Thoeries

3.1 The 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

3.1 The 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.

3.1 The Existence of Intraindustry Trade


Intraindustry Trade in the U.S., 2002 ( in Billion of Dollars)
Category
Motor Vehicles Electrical machinery Office machines Telecommunications equipment Power-generating equipment Industrial machinery Scientific instruments Transportation equipment Chemicals Apparel and clothing

Exports
60.39 82.7 39.7 24.9 34.4 31.8 29.2 46.1 16.8 8.0

Imports
168.1 81.2 76.9 66.3 34.0 35.2 20.9 20.2 30.2 63.8

3.1 The Existence of Intraindustry Trade

Reasons for Intraindustry Trade


Transportation Seasonal Manufacturers

costs

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

Chapter 3 Modern Trade Thoeries

3.1 The 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

3.2 Technological Gap, Product Life Cycle and International Trade

Technological gap is a cause of international trade and determines the flow of international trade.
Export of Country A and B

Production of Country A

T0

T1 Demand Lag Response Lag

T2

T3 Grasp Lag

Time Export of Country B Production of Country B

Imitation Lag

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. the time interval from the invention of new products in innovating countries to generic production until the import is zero. the time lag from the invention of new products to imitation of importing countries.

T0-T3: the stage of imitation lag

T0-T2: the stage of response lag

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.

3.2 Technological Gap, Product Life Cycle and International Trade

The technological gap theories explain the causes of trade among different countries from the perspective of comparative advantage, and prove that leading technology can form comparative advantage even among the countries with close endowments and tastes. However, the theory hasnt explained the transfer of trade flow and the causes of the emergence and disappearance of technological gap.

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

3.2 Technological Gap, Product Life Cycle and International Trade


Quantity Consumption in Inventing Countries Stage 1 Stage 2 Stage 3 Stage 4 Stage 5 Import Export Production in Inventing Countries Production in Imitating Countries Export Import O T1 T2 T3 Consumption in Imitating Countries T4 Time

Model of Product Life Cycle

3.2 Technological Gap, Product Life Cycle and International Trade


O- t1

the introduction of new products the growing period of products the maturing period of products 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. 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.

t1-t2

t2-t3

t3-t4

After t4

Chapter 3 Modern Trade Thoeries

3.1 The 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 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.

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.

Chapter 3 Modern Trade Thoeries

3.1 The 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

3.4 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.

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 industrys production.
Relationship of Input to Output for a Hypothetical Industry Output 5 10 15 20 Total Labor Input 10 15 20 25 Average Labor Input 2 1.5 1.3 1.25

25
30

30
35

1.2
1.17

3.4 Economies of Scale, Imperfect Competition, and International Trade


Price (dollars)

10,000 8,000 7,500 O

A B C Average Cost

100

200

275 Autos (thousands)

Economies of Scale as a Basis for Trade

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.

3.4 Economies of Scale, Imperfect Competition, and International Trade

Computers 125 D United States

South Korea

A C 100 Tons of Steel

Trade and Specialization under Decreasing Costs

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.

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.

3.4 Economies of Scale, Imperfect Competition, and International Trade


Average Cost, AC and Price, P CC AC3 P1 P2, AC2 AC1 P3 PP E

n1

n2

n3

Number of Firms, n

Equilibrium in Monopolistically Competitive Market

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.

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.

3.4 Economies of Scale, Imperfect Competition, and International Trade


Average Cost, AC and Price, P CC1

CC2 P1 P2 1 2

PP

n1

n2

Number of Firms, n

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 fall in the price of each.

Chapter 3 Modern Trade Thoeries

3.1 The 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

3.5 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.

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.