Chapter 5 Modern International Trade Theory

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Chapter 5 Modern International Trade Theory

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Section I The emergence and development of
modern international trade theory

• 1. The background
• the rise of transnational corporations
• economic globalization
• the multilateral trading system improvement and
  development
• challenged the traditional theory of
  international trade

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• theoretical assumptions has changed greatly
• comparative advantage
• factor endowments
• based on a series of stringent assumptions
• If these assumptions changed, they could lead to
  completely different conclusions.

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• 2. The development track
• Leontief questioned the H-O model
• Linde and Vernon made new trade basis from a
  dynamic point of view different from the
  comparative advantage of
• Krugman, new trade theory.
• Neoclassical general equilibrium analysis of
  trade theory of comparative advantage based on
  "international trade theory model of perfect
  competition,"
• new trade theory can be called "international
  trade is not perfect competition model."

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• Emergence of new trade theory has two main
  sources
• First, as the world's economic and trade
  development, the traditional trade theory has not
  convincingly explained the phenomenon of many
  important international trade
• Second, the development of the theory of
  industrial organization provides a solid
  theoretical basis for the emergence of new trade
  theory

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• 3.the relations between modern international
  trade theory with traditional trade theory
• Difference between the two theories
• (1) explained different phenomenon of trade, the
  former explained intra-industry trade between
  developed countries, while the latter focuses on
  inter-industry trade between the developed and
  developing countries

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• (2) theoretical basis is different, the former
  based on economies of scale and imperfect
  competition,the latter based on constant returns
  to scale and perfect competition.
• Therefore, the two are not substitutes, but
  complementary relationship, they shared a rich
  and developed system of international trade
  theory.

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Section II economies of scale and international
trade

• 1. the basic principle of economies of scale
• Economies of scale With the expansion of
  production scale and production increased, the
  output per unit of factor input will increase
  ,the average cost of products will decline.
  Microeconomics named it "increasing returns to
  scale" , also known as economies of scale.

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• Constant returns to scale in the best of the
  production scale, the average cost of the product
  has reached the lowest point, and to some extent,
  the average cost will not decline because of
  production increases. This phase is called the
  "constant returns to scale."

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• Decreasing returns to scale when the scale of
  production continued to expand, the average cost
  of production did not continued to decline
  because that the scale is too large and decrease
  the efficiency of management and co-operation.
  This phenomenon is called "decreasing returns to
  scale.

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long-term average costs and economies of scale
cost
LAC
decline
constant
rise
Q
O
Economies of scale
decreasing returns to scale
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• Internal economies of scale the average cost of
  firms decline with the expansion of production
  scale of its own.
• External economies of scale As the amount of
  firms increases and the relative concentration of
  enterprises so that the transaction costs in the
  information gathering, product sales and other
  aspects decline.

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2.external economies of scale and international
trade
P
P
S1
MC1
S1
AC1
MC2
S2
AC2
P1
LRAC
P2
D1
D2
Q
q
O
Q1
Q2
q1q2
O
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• Price drop from P1 to P2, trade expansion and
  average cost decline, the industry has a
  competitive advantage in the international market
  ,companies have active to export sports shoes,
  so international trade begins.

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• The distribution of trade benefits a single
  company can get economic profits at short-term
  equilibrium but long-term economic profit equal
  to zero.
• Short-term gains, long-term nothing to lose.

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• For consumers, long-term prices decreased,
  consumption increased, consumer surplus
  increased. Society as a whole was a net benefit
  of trade.

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• 3.the internal economies of scale and
  international trade
• (A) monopolistic competitor with internal
  economies of scale
• Its characteristics are large-scale enterprises,
  the products have different demand curves slope
  downward to the right.

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• A profit will attract firms go into the industry,
  the price decline, and profit reduce and
  economic profit is zero.
• A loss will let some manufacturers exit, the
  price rise, loss reduce until there is no
  economic and profit is zero.

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• Under the long-term competitive conditions, the
  company's AC line tangent to the demand curve,
  the product price is equal to its average cost,
  profit is zero.

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P
P1AC1
AC
MC
D
MR
Q
O
Q1
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• (B) monopolistic competitor participated in
  international trade

P
P1AC1
P2
AC
AC
MC
D2
MR2
D1
MR1
O
Q1
Q
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• Before participating in trading, the company is
  facing domestic demand curve, according to the
  principle of profit maximization ,MR1 MC, the
  production capacity of manufacturers is Q1.

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• After participating in trade, due to foreign
  demand, so the demand curve moves from D1 outside
  the D2, MR1 move outside the MR2, AC1 has dropped
  to AC2, the shaded area shall be short-term
  equilibrium, firms maximize their profits.

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• According to microeconomic theory, monopolistic
  competition had short-term profit, with the entry
  or exit of firms in long-term , the competition
  will lead to economic profits disappear,
  companies can only get the normal profit.

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P,C
P1LAC1
P3LAC3
LAC
D3
MC
D1
MR1
MR3
Q
O
Q1
Q3
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• Short-term impact of open trade business
  production increased, the average cost reduced,
  firms had short-term profits. Product prices may
  fall, consumer surplus increases. But the
  short-term prices may rise, resulting in
  decreased domestic consumption.

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• long-term impact of open trade enterprise
  production increased, the average cost and
  product prices fell and the two are equal,
  economic profit of enterprises is zero .
  Domestic consumption and consumer surplus
  increased.

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• (C) internal economies of scale, monopolistic
  competitors, intra- industry trade

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C,P
C,P
The U.S.
JAPAN
2.0
2.0
1.5
LAC
LAC
0
0
Truck Q
100
200
Truck Q
100
Export to the U.S.
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JAPAN
The U.S.
C,P
C,P
2.0
2.0
1.5
LAC
LAC
0
100
200
Car Q
0
100
Car Q
Export to Japan
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• Before trade between the United States and Japan,
  two countries produce some trucks and some cars
  Japanese produce 100 trucks and 100 cars, the
  U.S. also do so.
• Costs topped 20 thousand U.S. dollars because
  market size is small .

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• After trading, enterprises can bring the cost
  down by expanding the production scale.
• For example, Japan will expand production scale
  of truck to 200 units, prices fell to 15 thousand
  U.S. dollars U.S. expand car production to 200
  vehicles, prices fell to 15 thousand U.S.
  dollars.

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• Two-way trade is based on economies of scale,
  rather than technical differences or the
  allocation of resources generated by different
  comparative advantages.

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Section III Imperfect Competition and
International Trade
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• 1. Imperfect competition in
• international trade
• Perfect competition free market competition with
  the absence of any interference and obstacles .
• Perfect competition must meet the following
  conditions.(3-4)

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• Monopoly the production and sale of a product
  entirely controlled by a vendor. Monopolist is a
  price maker rather than price taker.

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• Imperfect competition imperfect competition is
  that market conditions included both monopoly
  and competition factors. Or that is market status
  between perfect competition and monopoly.
  Imperfect competitive market structure vary
  widely, there is not a fixed and unified
  theoretical framework to describe it. But there
  are two forms of specific market theory of
  imperfect competition often became the object of
  study monopolistic competition and oligopoly.

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• 2. Price discrimination and international trade
• Price discrimination refers that although product
  sold is the same, but in different markets or to
  charge different consumers different prices. Such
  price discrimination of international trade often
  referred to "dumping", the income is brought by
  "dumping" to the enterprise export encouragement
  , it can explain the trade cause of imperfect
  competition firms.

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• price discrimination must meet three necessary
  conditions ? imperfect competition? market
  segmentation? the flexibility of demand curve
  that different manufacturers faced on the market
  is different (assuming in the foreign market, the
  price elasticity of demand is greater than that
  of the national market).

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• Dumping definition the price of goods sold to
  foreign markets less than the "normal price" is
  referred to as dumping. "Normal price" determined
  by the following three ways
• Exporting country's domestic market prices
• The price of export to third countries

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• Structural prices the total of production
  costs, marketing costs, management and
  administration costs and reasonable profits.
• The importance of these three ways determined the
  "normal price" is decreasing, we can use the
  second approach under the condition only the
  first method does not apply, when the second does
  not apply, we can use third. Dumping is a price
  discrimination.

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Profits Maximization and Dumping
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• When the output is Q, the marginal cost is MCE
  QE. In accordance with the requirements of
  profits maximization, companies in every market
  should be marginal revenue equals marginal cost,
  then the horizontal line along the MCE in (a) and
  (b) find the Ed and Ef (QE QfEf QdEd), which
  two points are the production of the two market
  equilibrium. To maximize the total output Q
  profits, domestic sales of Qd, the foreign sales
  of Qf, Q Qd Qf.

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• The price of domestic and foreign market is
  respectively Pd and Pf, and Pdgt Pf. That foreign
  sales price is lower than the domestic prices is
  dumping. Marginal of dumping is the Pd-Pf.

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Section IV intra-industry trade

• 1. the definition of intra-industry trade and
  calculation
• Intra-industry trade is defined that in the same
  period, firms import and export the products of
  the same industry.

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• 60 years of the 20th century, economics began to
  pay attention with the intra-industry trade
  phenomenon.
• In 1960, Verdoorm analyzed the impact of the
  "Benelux alliance" to three countries in a paper,
  and found that the three countries specialization
  is in the same industry, between different
  branches.

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• In 1966, after analyzing the trade situation of
  the Member States of the European Community
  Balassa found that the majority of the trade
  growth of European countries is in the
  international standard classification of goods
  trade group, not in goods between the groups.

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• Grubel Lloyd are the first economists who
  analyzed the intra-industry trade phenomenon. In
  1975, they published Intra-Industry Trade," it
  made a more systematic explanation to
  intra-industry.

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• We usually use intra-industry trade index (index
  of intra-industrial trade, IIT) to measure a
  degree of intra-industry trade.

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• 2.intra-industry trade is the result of economies
  of scale and imperfect competition
• (1) intra-industry trade of the same products
• G L thought that this is caused by the costs of
  transport, storage, sales and packaging.

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• (2)Intra-industry trade of different products
• G L thought that it can be divided into two
  categories to count ,one is the product of
  mutual substitution ,another is the product of
  similar production inputs.

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• Production inputs can be completely replaced, but
  very different products, such as wooden and steel
  furniture, we can use H-O model to explain
• some of that product inputs is similar but not
  quite able to replace are "joint products", which
  can also use resources advantage to explain

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• (3) The causes of intra-industry trade of
  homogeneous products
• Transport costs and geographical location
• Price distortions caused by government
  intervention, especially dumping each other,
  making a country imports and export the same
  product to occupy the market of other countries .

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• Homogeneous product trade caused by seasonal
  production and use.
• Statistical reasons.
• The first is entrepot trade,
• The second situation is mostly due to statistical
  coverage on the same intermediate products and
  finished products and components into the same
  set of products to form the intra-industry trade.
  

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Section V international trade based on
differences in the dynamic technology
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• When factor endowment theory study the reasons of
  international trade, it assumed that the two
  countries used the same technology in production,
  the production function of the same kinds of
  products is the same. But in reality that the
  technology every countries used does exist gap,
  and this gap is dynamically changing.

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• To explain the causes of international trade and
  trade patterns based on the change in technology
  ,in 1961, the U.S. economist Posner firstly
  proposed the technology gap theory and gave an
  explanation.
• A large number of trade between industrialized
  countries is based on new products and new
  technology.

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• Because of the patent and trademark protection,
  new products and new technology makes the
  innovation the country temporarily residing in
  the world market monopoly, as a major producer
  and exporter.
• Until maturity of the technology and new products
  by the importing country's producers to obtain,
  they will use their cheap labor to imitate the
  production and export the product, and even
  exported to countries with advanced technology
  invention.

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• At the same time, the first technological
  invention countries may have updated the product,
  using the update process and technology. Then a
  new round of technological gap has created.

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• In 1966, Vernon developed the life-cycle theory
  based on the principle of technology. The theory
  is that the technological development of a new
  product generally has three stages new product
  stage, the stage of maturity and standardization.

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• Stage I Technology is in the stage of invention
  and innovation, the product was new, in addition
  to the invention countries, other countries know
  little about the technology. The invention State
  monopolized the products to meet consumer demand
  at home and abroad. New products are often
  firstly in a few developed countries.

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• Stage II technology maturity, production has
  been relatively standardized. As a mature
  production technology will be as exports and
  transfer, at the same time, overseas production
  will increase, invented country's exports began
  to decline, some importing countries imitated and
  mastered the techniques quickly and then produced
  at home, exported to other countries .

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• Stage II technology is no longer new and secret,
  many technology included in machine. As long as
  purchasing these machines ,any country can get
  these technology and the importance of the
  technology itself has been gradually
  disappearing.

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• Dynamic understanding As the product life cycle
  stage changes, the determinants affecting the
  comparative advantage is changing.
• Therefore, different types of countries can be in
  different stages of comparative advantage

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Section VI the trade patterns decided by demand
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• 1.The factors that determine demand
• (1) the actual demand
• (2) love preference
• (3) income levels.

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• 2. Income elasticity of demand and the Engel law
• (1) Income elasticity of demand
• People made a demand response to income changes
  is "the income elasticity of demand", that is,
  the ratio of the percentage changes in demand and
  the percentage change in income

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• ? the percentage change in demand on the A /
  the percentage in income changes
• ?gt 1, the ratio of the increased demand to A is
  over the ratio of the increased income
• ?lt1, the ratio of the increased demand to A is
  less than the ratio of the increased income

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• ? lt0, income increased, consumer demand for goods
  A reduced.
• According to value of income elasticity of
  demand of goods, economists divided goods as
  "luxury items" (?gt 1), "necessities" (1gt ?gt 0)
  and the "inferior goods "(? lt0).

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• (2)Engel law
• After valuating the income elasticity of demand
  of various commodities, people can illustrate the
  different needs based on income differences and
  predict changes in demand. according to the
  increase in revenue

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• Engel (Erns Engel) pointed out that with the
  growth of per capita income, the ratio that
  people spend on food expenses to income will be
  less and less. His conclusion have been proven by
  many facts , this argument in economics was
  called the "Engel Law."

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• The significance of trade of Engel law is not
  limited to analyze in food products, we can use
  this law to describe the primary products,
  especially changes in demand for complementary
  products.

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• When the economy is growing and the level of
  national income is increasing , national demand
  for commodities will gradually shift from
  agricultural to industrial goods. This not only
  explains why the developed and developing
  countries have different patterns of demand, but
  also explains why the world trade development
  from primary products to industrial products .

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• 3. overlapping demand theory
• Overlapping demand theory has been called the
  Theory of Demand Preference. It is made by the
  Swedish economist Lindel in 1961. Lindel thought
  that H-O theory can explain the pattern of trade
  of primary products, more generally, to explain
  the trade patterns of natural resource-intensive
  products, but this theory does not explain
  patterns of trade of manufactured goods.

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• Overlapping demand theory Demand explained the
  causes of intra-industry trade from the demand
  point. Lindels theory made a assumptions that
  consumer preferences largely depend on their
  income level, a country's per capita income
  levels determined the country-specific preference
  patterns and demand structure.

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• Which the structure of demand has to a large
  extent determine the country's production
  structure. Thus, a national production of various
  products reflects the country's per capita income
  levels. The specific commodity structure became
  the basis of the export.

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Overlapping demand

• New products of a country must first meet their
  needs, and then exported to foreign countries -
  to meet foreign demand. Therefore, the structure
  of demand between the two countries (demand
  preferences) the more similar the two countries
  more likely to trade.

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• Demand structure of a country depends on the
  country's income level. That countries average
  income level is different, its demand structure
  is different.

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• Therefore, the level of per capita income between
  the two countries closer, the more similar the
  demand structure, the greater the mutual needs,
  the more the volume of trade.

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• A country's average or per capita income will
  determine the a particular preference. Countries
  with high per capita income will need
  high-quality manufactured goods (luxury goods),
  while countries with low per capita income would
  be on the low quality of products (a necessity) .
  So a country with which type is most likely in
  countries deal?

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• Lindel hypothesis gave the explanation that
  country of per capita income levels close, its
  structure of demand is overlap, may be the same
  type of consumer products. Therefore, the rich
  countries (industrialized countries) will want to
  trade with other rich countries, poor countries
  (developing countries) may form a trade partner
  with other poor countries. As Lindel explain
  international trade patterns from overlapping
  demand perspective, his hypothesis wolud be known
  as the overlap theory.

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• Horizontal axis represents a country's per capita
  income level (Y), vertical axis represents a
  country's quality of various goods (Q).
• The more higher the goods required , the more
  higher its quality level. The higher per capita
  income levels, the higher quality level of
  consumers goods .The relationship between them
  can express with OP from the diagram.

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• 4. international trade due to the difference of
  demand preferences
• If the production possibility curve (PPF curve)
  is the same , there is not trade between two
  countries. The introduction of the concept of
  preference, the situation will change. Preference
  is also important reasons to form comparative
  advantage or disadvantage .

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• PPF curves represent the productive capacity of
  different countries, if it is the same,
  indicating the production possibility from the
  supply perspective there is no difference between
  the two countries.

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• Indifference curve represent consumer preference
  or consumer desire of different countries .
  Different indifference curves represent different
  preferences of different countries. As long as
  the indifference curve is not the same ,the trade
  between countries is still possible.