For a long time we were happy with the old trade theory featuring comparative advantage and its more modern trade theorems.

Gradually, we began to think more about an important phenomenon that grows with the progress of globalization. That was two-way trade in very similar products.

We need to consider theories reflective of more modern, global conditions.

Traditional theory was based on a market structure basically of perfectly competitive markets.

It was derived from the days when the world was much larger, technology barriers were greater, transportation costs were higher, etc.

It saw normal markets in the domestic economy. Aside from those, some sectors produced, almost just parenthetically and definitely peripherally, for “foreign” trade.

From the 60s to the 80s, trade between industrialized countries rose from 45 to 55% of world trade.

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Exports Imports Total

USAROW

Intra-industry trade is what we call trading of similar goods, e.g. Hondas for VWs, Boeing for Airbus planes, etc.

(We look at the magnitude of matched exports plus imports, not net trade.)

Of major industrial countries, only Japan demonstrated a declining IIT between 1970 and 1987.

IIT = Intra-industry TradeIIT + Inter-industry trade = 1, orIIT = 1 - Inter-industry trade.

Calculated as a percentage, the IIT share is equal to 100 percent minus the percentage share of net or inter-industry trade in the country’s overall trade. If the sum of inter-industry trade [X-M] is zero, IIT is 1 or 100%. If all trade were inter-industry, X=M, IIT would be zero.

Sorry,Sorry,Wrong class!Wrong class! Again, the calculation is:

IIT = 1 - sum of |X-M| sum of X + M

This answers the question: “What share of our total exports and imports is matched by imports and exportsof the same kinds of commodities?”

In Ricardo, a country imports 20A (exporting 0A) and exports 15B (importing 0B). Where all trade is inter-industry, we have

IIT = 1 - |(0-20)| +|(15-0)| = 1 - 1 = 0 20 + 15

So with only inter-industry trade, IIT has to be 0.

Now, assume all trade is modern, intra-industrial trade. The same nation may still import 20A and export 15B, but also exports 20A and imports 15B. So we get

IIT = 1 - |(20-20)| +|(15-15)| = 1 - 0 = 1 35 + 35

In the more realistic general case, where a nation may export a million units and import only half a million units of a commodity, we would have IIT between 0 and 1.

LRAC

Because of scale economies, some

industries are global oligopolies since in

some industries, the exploitation of scale

economies leads to the domination of some

industries by particular firms.

LRAC

Consider the natural monopoly and its

growth, aided by scale economies.

LRAC

Economies of scale: specialization within the firm; Intensive capital equipment and automation, bulk purchases from suppliers, etc.

LRAC

Diseconomies of scale: excessive size renders imperfect the efforts to achieve effective communication and coordination

What we have been discussing are Internal economies. Where they exist AC declines as the firm expands through greater specialization, specialized machines, or spreading of fixed costs.

External economies These relate to the size of the entire industry in a specific geographic area.

AC declines as output expands if concentrating the industry gives rise to better input markets (concentrated pools of skilled labor, etc.)

Or AC declines as output expands if concentrating the industry gives rise to new knowledge, then this knowledge diffuses quickly among firms in the area.

(This explains clustering of some industries in Silicon Valley, banking and finance in New York, watch production in Switzerland.) We may see oligopoly or monopolistic competition in such instances.

Paul Krugman, an important contributor to the new theory, writes about external economies:

“It is important not only that an individual business be large enough to compete, but that it be embedded in an

industry -- or cluster of industries -- that is large enough to support the pool of skilled labor, the

specialized suppliers, and the flow of knowledge that allow it to prosper.” (See Peddling Prosperity, p. 227)

Consider the importance of imperfectly competitive markets for the modern trade theory. As in the case of monopolistic competition, entry causes the level of the demand curve to fall, driving prices down.

As in monopolistic competition, where entry into the market is not difficult, prices for such things as retail commodities and services stay very favorable for consumers by modern trade practices.

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Entry

Because of product differentiation and its accompanying marketing practices, net trade can be the result of differences in international marketing capabilities and responding consumer tastes.

Note how consumers responded to Japanese car development, focussing on smaller car models, good marketing, and a reputation for high quality at reasonable prices.

Opening or expanding trade has little of the impact on factor (e.g., labor) incomes that we would expect (via the Stolper-Samuelson Theorem) for traditional trade based on comparative advantage.

If scale economies are substantial, production will be concentrated in a few countries.

Often, trade patterns are established through historical quirks. (“History matters”).

Production locations and trade patterns tend to persist, even if other locations are potentially lower-cost.

Other locations can’t overcome the scale advantages of established production. Other locations may view this as an infant-industry problem.