new_trade_theory abridged.doc

7/26/2019 new_trade_theory abridged.doc

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Notes on Increasing Returns and New Trade Theory

Increasing returns

Internal economies of scale: doubling your output does not requiredoubling of your cost. In other words, the average cost of

production decreases with increased output.

A simple eample

!" production technology #apan production technologycomputer auto $omputer auto

%ol A$ %ol A$ %ol A$ %ol A$

&' mil (&'' &' mil (&'' &' mil (&'' &' mil (&''

)' mil (*' )' mil (*' )' mil (*' )' mil (*'

$losed economy

!" current production #apan current productioncomputer auto $omputer auto

%ol A$ %ol A$ %ol A$ %ol A$

&' mil (&'' &' mil (&'' &' mil (&'' &' mil (&''

&



+ossible production allocation with trade

!"

production A$ consumption eport

computer )' mil (*' &' mil &' milAuto ' &' mil &' mil

#apan

production A$ consumption eport

computer ' ' &' mil &' mil

Auto )' mil (*' &' mil &' mil

In the new allocation with trade, world production and individualcountry consumption remain the same. -owever, the cost of

production goes down for both goods.

uestion:At what price will the goods be available to consumers/Increasing returns are usually associated with a monopoly instead

of a firm facing perfect competition.$an the above allocation be reali0ed as a mar1et equilibrium/

-owever, note one similarity to the traditional trade model: Itmight be possible for both countries to benefit from trade by eachrestricting the number of goods produced 2speciali0ation3 andepand the production of the remaining goods. In this case, thereason for speciali0ation comes not from differences in technology

or in factor abundance, but from increasing returns.

)



4ach firm produces a different variety of the same good. "o asmar1et si0e increases, the number of firms and the number ofvarieties increase. And these varieties are available at a lower

price.

5



Increasing return and trade

6et7s say before trade, the equilibrium number of firms in eachcountry is *. "o * varieties of the good are produced in each

country.

8hen the two countries open up to trade so that the two mar1etsare integrated, the mar1et si0e doubles.The new equilibrium number of firms in the world is between *and &', say 9."o consumers in each country now have 9 varieties available tothem instead of *. And these varieties are available at a lower price

than before trade.



After trade, there is a consolidation in this industry: the totalnumber of firms goes from &' to 9.Is this bad/ ;oes this mean that the surviving firms have moremonopoly power/

Apply this model to trade among 4uropean countries. 8hat is oneof the benefits of the 4uropean !nion/

*



Another type of increasing return

;ynamic increasing return:

The unit cost of production decreases as the cumulative volume of production goes up.

watch eample

The unit cost curve might be decreasing for two different reasons:

6earningbydoing 2learning curve or eperience curve3

4ternal economies of scale"peciali0ed suppliers<nowledge spillovers6abor mar1et pooling

Implication of dynamic increasing returns for trade

=ives rise to firstmover advantage.

Trade patterns need not be determined by comparative advantageor factor endowment, but by chance > who the first one was.

?



Illustration of benefit of labor mar1et pooling:

Tinseltown 4conomics

8atch the #oe $anada videohttp:@@www.youtube.com@watch/vpnp%-B1IbC9

8hat happened to #oe $anada/http:@@www.sfgate.com@[email protected]/f@c@a@)''&@'&@)&@DN&B&B)?.;T6EhwNF%AG"$FTIAG$ANA;AEsn'')Esc9B9

B

http://www.youtube.com/watch?v=pnpVH7kIb_8

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2001/01/21/MN171726.DTL&hw=NOVA+SCOTIA+CANADA&sn=002&sc=878



http://www.youtube.com/watch?v=pnpVH7kIb_8




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new_trade_theory abridged.doc