Ch6_Alternative Theories of Trade

Ch6_Alternative Theories of Trade - ALTERNATIVE THEORIES OF...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: ALTERNATIVE THEORIES OF TRADE 1 Overview • Why do developed countries trade with each other so much? • Why is there so much cross-trade in similar products? • H-O theory doesn’t have an answer for this • One answer is: Economies of Scale Economies Internal economies External economies 7 Review • Trade means that you export what you make export relatively cheaply, and import the other import • Absolute or Relative advantage: Differences in technologies (or costs) drive trade • Heckscher-Ohlin; same technologies: Differences in factor endowments drive trade 8 •1 Challenges to the H-O Theory • • • The pastoral version of H-O trade is that trade should take place between dissimilar countries or regions Developed Developing (or not so developing) Resource rich Resource poor Capital rich Labor rich etc. We see these flows but we also see flows that don’t seem consistent with the H-O view of the world For example, H-O would not predict that Canada would be the No. 1 trading partner for the U.S. 9 Challenges to the H-O Theory • • There is substantial trade between industrialized countries, that is, countries that have similar technologies, factor endowments, and consumption structures Moreover, they exchange very similar products This is called intra-industry trade International trade often involves large firms operating in imperfectly competitive markets. For example: imperfectly Boeing and Airbus in commercial aircrafts Intel and Motorola in microprocessors 10 Challenges to the H-O Theory • Trade among developed regions is actually quite common within a country but we don’t seem surprised by it Why does California (an industrialized state) import cars from Michigan? Why does California export banking services to Nevada? Why does NYC export financial services to the rest of the country? Why does Michigan produce car components all over North America? Would show up as intra-industry trade in the stats 11 •2 12 Patterns of U.S. Trade Product (billions $) Wheat Corn Soybeans Coal Petroleum and Petroleum Products Aircraft Chemicals Precision instruments Iron and Steel Computers Motor Vehicles Clothing and accessories Shoes and other footwear U.S. Exports 4.5 5.0 4.4 4.2 6.3 36.6 43.6 14.9 4.1 17.6 37.9 4.2 small U.S. Imports small small small small 53.9 7.5 28.3 7.8 10.2 22.9 77.1 33.2 10.2 13 Intra-Industry Trade • The “Intra-Industry Trade” index is defined as: IIT j 1 sum of X j M j sum of X j M j Xj = Exports of G&S produced by the jth industry Mj = Imports of G&S produced by the jth industry IIT = 0 if Xj or Mj is zero (no intra-industry trade) IIT 1 as Xj Mj (there is only intra-industry trade) 14 14 •3 Intra-Industry Trade (IIT) as a Percentage of Trade in Nonfood Manufactured Goods with other Industrialized Countries Country 1970 1987 United States 45.3 51.0 Canada 44.8 55.7 Japan 23.6 22.2 West Germany 58.9 65.5 France 65.5 72.3 United Kingdom 57.8 68.8 15 Why Intra-Industry Trade? • There is more IIT when Trade barriers are low Transport costs are low There is product differentiation • What are the causes from the production side? 16 Why Intra-Industry Trade? • Economies of Scale There are economies of scale if the unit cost of economies production declines as more units are produced Internal economies of scale Pertain to a particular firm Unit costs decline as the firm expands External economies of scale Pertain to a particular industry within a geographic area Unit costs of each firm decline as the industry expands 17 •4 Monopolistic Competition • Under certain conditions of economies of scale, an industry can exhibit monopolistic competition Modest economies of scale Allow many firms to exist Differentiated products Allow for some price control If scale economies are very strong, then we may get an oligopoly 19 An Aside on Marginal Revenue • Rev = P*Q • Firms maximize revenue by Marginal Revenue (MR) = Marginal Cost (MC) • Market power in the product markets doesn’t change MC • But MR depends on the firm’s power in the product markets • Here is why 20 An Aside on Marginal Revenue • Rev = P*Q • ΔRev = ΔP*Q + ΔQ*P + ΔQ* ΔP This is the fundamental theorem of calculus, and we ignore the last term, because for small changes it is very small. So • ΔRev = ΔP*Q + ΔQ*P • If the firm changes its production a little (ΔQ), its revenue will be: 21 •5 An Aside on Marginal Revenue • If the firm changes its production a little (ΔQ), its revenue will be: MR P Re v P Q Q This just says that if it increases output by one unit, it will receive P, the price, but Lose a little from all the other sales if the additional output makes the price drop 22 An Aside on Marginal Revenue MR Re v P P Q Q • If the market is fully competitive, then MR Re v P MC Q the usual competitive markets condition 23 An Aside on Marginal Revenue • If the firm has monopoly power, then MR MC MR P P MC P Q 24 •6 An Example MC Monopoly Price Competitive Price MR Demand P*Q – AC*Q = Monopoly Profits 25 Monopolistic Competition (cnt) • Firms have the ability to set a price different from competitors because of product differentiation • But free entry makes sure that firms do not free make profits (above the normal rate) 26 Monopolistic Competitive Markets (cnt) Before Opening to Trade Prior to equilibrium 27 •7 Monopolistic Competitive Markets (cnt) Before Opening to Trade 28 Monopolistic Competitive Markets (cnt) • Opening to trade: The producer can export to consumers in the rest of the world The demand function shifts to the right The producer will face some additional competition from foreign producers: The demand function becomes flatter 29 Monopolistic Competitive Market (cnt) After Opening to Trade 31 •8 Monopolistic Competitive Market (cnt) Before and After Opening to Trade Bigger Market 32 Monopolistic Competition Excess Profits P>AC Excess Profits Excess Profits AC Function MC Function Demand MR 34 Monopolistic Competition No Excess Profits (Equilibrium) P=AC No Excess Profits AC Steep demand curve; low elasticity; high pricing power MC 35 •9 Effect of Demand MC AC Flat demand curve; high elasticity; low pricing power 36 Large Internal Scale Economies • When the internal scale economies are large, the industry may become an Oligopoly Literally means few sellers • Each firm operates strategically because it is “large” it knows its actions will affect the actions of the other firms 40 Large Internal Scale Economies • Production tends to be concentrated in a few countries These countries are likely to be net exporters of the product • Location matters because production may not be concentrated in countries with the lowest cost Once established, it is difficult to change production location through market forces 41 •10 External Scale Economies • External scale economies means that each firm in the industry has a standard upwardsloping marginal cost curve when the industry-wide scale of production grows, all firms’ marginal costs fall MCs are still upward-sloping 42 External Scale Economies • Firms operate competitively. Their production costs depend on the size of the industry Price Demand in closed economy Demand in open economy Sum of individual firms’ costs for different industry sizes Industry average cost reflecting external economies Quantity 43 43 Gains and Losses • Exporting country: Producer surplus increases due to the increase in production mitigated somewhat by the decrease in price Consumer surplus increases • Importing country: • Producer surplus declines because the production declines or may be even eliminated Depends on just how the externality works • Consumer surplus increases 44 •11 Gains and Losses 45 For Discussion How would you characterize • The auto industry? • The steel industry? • The airline industry? • Your favorite industry? 46 Trade Affects A Country’s Technology • Trade provides access to new products. Specially important are capital goods which embody better technologies • Trade creates incentives to innovate because greater competition creates the need to improve productivity • Trade also creates incentives to innovate because it gives access to a larger market over which R&D fixed costs can be spread • Specialization in low-tech industries may be detrimental to the long-run growth of countries 47 •12 Example of Scale Economies • Two nations: US and UK, two types of cars Cheap Car Labor Output 10 5 15 10 20 15 25 20 30 25 35 30 Expensive Car Labor Output 20 5 25 10 30 15 35 20 40 25 45 30 48 Key Summary Points • Modest internal economies of scale (IES) Monopolistic competition with large numbers of varieties Trade opening increases variety and reduces prices • Large internal economies of scale Production is concentrated in a few countries They export to the rest of the world • External economies of scale (EES) Industry-wide costs fall with more demand Exports rise, price falls 51 THE END 52 52 •13 ...
View Full Document

This note was uploaded on 02/15/2011 for the course FBE 462 at USC.

Ask a homework question - tutors are online