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Chapter 5 Modern International Trade Theory

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Title: Chapter 5 Modern International Trade Theory


1
Chapter 5 Modern International Trade Theory
  • ????????

2
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

3
  • 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.

4
  • 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."

5
  • 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

6
  • 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

7
  • (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.

8
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.

9
  • 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."

10
  • 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.

11
long-term average costs and economies of scale
cost
LAC
decline
constant
rise
Q
O
Economies of scale
decreasing returns to scale
12
  • 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.

13
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
14
  • 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.

15
  • 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.

16
  • For consumers, long-term prices decreased,
    consumption increased, consumer surplus
    increased. Society as a whole was a net benefit
    of trade.

17
  • 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.

18
  • 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.

19
  • 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.

20
P
P1AC1
AC
MC
D
MR
Q
O
Q1
21
  • (B) monopolistic competitor participated in
    international trade

P
P1AC1
P2
AC
AC
MC
D2
MR2
D1
MR1
O
Q1
Q
22
  • 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.

23
  • 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.

24
  • 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.

25
P,C
P1LAC1
P3LAC3
LAC
D3
MC
D1
MR1
MR3
Q
O
Q1
Q3
26
  • 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.

27
  • 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.

28
  • (C) internal economies of scale, monopolistic
    competitors, intra- industry trade

29
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.
30
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
31
  • 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 .

32
  • 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.

33
  • Two-way trade is based on economies of scale,
    rather than technical differences or the
    allocation of resources generated by different
    comparative advantages.

34
Section III Imperfect Competition and
International Trade
35
  • 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)

36
  • Monopoly the production and sale of a product
    entirely controlled by a vendor. Monopolist is a
    price maker rather than price taker.

37
  • 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.

38
  • 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.

39
  • 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).

40
  • 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

41
  • 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.

42
Profits Maximization and Dumping
43
  • 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.

44
  • 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.

45
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.

46
  • 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.

47
  • 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.

48
  • 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.

49
  • We usually use intra-industry trade index (index
    of intra-industrial trade, IIT) to measure a
    degree of intra-industry trade.

50
  • 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.

51
  • (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.

52
  • 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

53
  • (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 .

54
  • 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.

55
Section V international trade based on
differences in the dynamic technology
56
  • 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.

57
  • 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.

58
  • 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.

59
  • 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.

60
  • 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.

61
  • 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.

62
  • 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 .

63
  • 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.

64
  • 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

65
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66
Section VI the trade patterns decided by demand
67
  • 1.The factors that determine demand
  • (1) the actual demand
  • (2) love preference
  • (3) income levels.

68
  • 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

69
  • ? 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

70
  • ? 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).

71
  • (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

72
  • 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."

73
  • 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.

74
  • 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 .

75
  • 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.

76
  • 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.

77
  • 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.

78
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.

79
  • Demand structure of a country depends on the
    country's income level. That countries average
    income level is different, its demand structure
    is different.

80
  • 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.

81
  • 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?

82
  • 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.

83
  • 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.

84
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85
  • 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 .

86
  • 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.

87
  • 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.
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