International Economics
Chapter 3
Modern Trade Theories
Chapter 3 Modern Trade Thoeries

3.1 Existence of Intraindustry Trade
 3.2 Technological gap, Product life Cycle and
International Trade
 3.3 Theory of Overlapping Demands
 3.4 Economies of Scale, Imperfect competition,
and International Trade
 3.5 Reciprocal Dumping
3.1 Existence of Intraindustry Trade

Advanced industrial countries have increasingly
emphasized intraindustry trade —two-way trade in
a similar commodity.
 Intraindustry trade involves flows of goods with
similar factor requirements. countries that are net
exporters of manufactured goods embodying
sophisticated technology also purchase such goods
from other countries.
3.1 Existence of Intraindustry Trade
Intraindustry Trade in the U.S., 2002
( in Billion of Dollars)
Category
Exports
Imports
Motor Vehicles
60.39
168.1
Electrical machinery
82.7
81.2
Office machines
39.7
76.9
Telecommunications equipment
24.9
66.3
Power-generating equipment
34.4
34.0
Industrial machinery
31.8
35.2
Scientific instruments
29.2
20.9
Transportation equipment
46.1
20.2
Chemicals
16.8
30.2
Apparel and clothing
8.0
63.8
3.1 Existence of Intraindustry Trade

Reasons for Intraindustry Trade
Transportation
costs
Seasonal
Manufacturers
in each country produce for the
“majority” consumer tastes within their country while
ignoring “minority” consumer tastes
Overlapping demand segments in trading countries
Economies of scale
Chapter 3 Modern Trade Thoeries

3.1 Existence of Intraindustry Trade
 3.2 Technological gap, Product life Cycle and
International Trade
 3.3 Theory of Overlapping Demands
 3.4 Economies of Scale, Imperfect competition,
and International Trade
 3.5 Reciprocal Dumping
3.2 Technological Gap, Product Life Cycle and
International Trade

Technological gap is a cause of international trade
and determines the flow of international trade.
Export of Country A and B
Production of Country A
T0
T1
T2
Demand Lag
Response Lag
T3
Grasp Lag
Imitation Lag
Time
Export of Country B
Production of Country B
3.2 Technological Gap, Product Life Cycle and
International Trade

T0-T1: the stage of demand lag


T0-T3: the stage of imitation lag


the time lag from the invention of new products to imitation of importing
countries.
T2-T3: the stage of grasp lag


the time interval from the invention of new products in innovating countries
to generic production until the import is zero.
T0-T2: the stage of response lag


the time lag from the invention of new products in innovating countries to the
acceptance of importing countries.
from imitation to no import until the generic production can meet domestic
demand and turn to export.
T1-T3 is the trading period caused by technological gap.
3.2 Technological Gap, Product Life Cycle and
International Trade

The technological gap theory explains the causes of trade
among different countries from the perspective of
comparative advantage, and proves that leading
technology can form comparative advantage even among
the countries with close endowments and tastes.
 However, the theory hasn’t explained the transfer of trade
flow and the causes of the emergence and disappearance
of technological gap.
3.2 Technological Gap, Product Life Cycle and
International Trade

The life cycle of products means all products will
experience the course of innovation, growth,
maturity and decline.
The stage of new products
The stage of mature technique
The stage of standardization
3.2 Technological Gap, Product Life Cycle and
International Trade
Quantity
Consumption in Inventing Countries
Stage 1 Stage 2 Stage 3 Stage 4 Stage 5
Import
Production in Inventing Countries
Export
Production in Imitating Countries
Export
Consumption in Imitating Countries
Import
O
T1
T2
T3
T4
Model of Product Life Cycle
Time
3.2 Technological Gap, Product Life Cycle and
International Trade

O- t1


t1-t2


the maturing period of products
t3-t4


the growing period of products
t2-t3


the introduction of new products
The innovating country can manufacture the identical cheaper products than
the inventing country by native cheap non-skilled labor, sell in the
international market and compete with the inventing country.
After t4

Imitation countries begin to sell products to the inventing country, and the
output of the inventing country will decrease so substantially as to come to a
full stop. And the life cycle of the products will finish.
Chapter 3 Modern Trade Thoeries

3.1 Existence of Intraindustry Trade
 3.2 Technological gap, Product life Cycle and
International Trade
 3.3 Theory of Overlapping Demands
 3.4 Economies of Scale, Imperfect competition,
and International Trade
 3.5 Reciprocal Dumping
3.3 Theory of Overlapping Demands
 Wealthy
(industrial) countries will likely trade with other
wealthy countries, and poor (developing) countries will
likely trade with other poor countries. The Linder
hypothesis is thus known as the theory of overlapping
demands.
3.3 Theory of Overlapping Demands

Linder does not rule out all trade in manufactured
goods between wealthy and poor countries.
There
will always be some overlapping of demand
structures: some people in poor countries are wealthy,
and some people in wealthy countries are poor.
However, the potential for trade in manufactured goods
is small when the extent of demand overlap is limited.
Chapter 3 Modern Trade Thoeries

3.1 Existence of Intraindustry Trade
 3.2 Technological gap, Product life Cycle and
International Trade
 3.3 Theory of Overlapping Demands
 3.4 Economies of Scale, Imperfect competition,
and International Trade
 3.5 Reciprocal Dumping
3.4 Economies of Scale, Imperfect Competition, and
International Trade

Many industries are characterized by economies of scale
(also referred to as increasing returns), so that the more
efficient production is, the larger the scale at which it
takes place.
3.4 Economies of Scale, Imperfect Competition, and
International Trade

Where there are economies of scale, doubling the inputs to an
industry will more than double the industry’s production.
Relationship of Input to Output for a Hypothetical Industry
Output
Total Labor
Input
Average Labor
Input
5
10
2
10
15
1.5
15
20
1.3
20
25
1.25
25
30
1.2
30
35
1.17
3.4 Economies of Scale, Imperfect Competition, and
International Trade
Price (dollars)
10,000
A
B
8,000
7,500
C
Average Cost
O
100
200
275 Autos (thousands)
Economies of Scale as a Basis for Trade
3.4 Economies of Scale, Imperfect Competition, and
International Trade

Economies of scale provide additional cost incentives for
specialization in production.
 Instead
of manufacturing only a few units of each and every
product that domestic consumers desire to purchase, a country
specializes in the manufacture of large amounts of a limited
number of goods and trades for the remaining goods.

Specialization in a few products allows a manufacturer to
benefit from longer production runs which lead to
decreasing average costs.
3.4 Economies of Scale, Imperfect Competition, and
International Trade
Computers
125
D
The United States
South
Korea
B
A
C
100
Tons of Steel
Trade and Specialization under Decreasing Costs
3.4 Economies of Scale, Imperfect Competition, and
International Trade
As
South Korea moves to the right of Point A along its
PPF, the relative cost of steel continues to decrease
until South Korea totally specializes in steel production
at Point C.
Similarly, as the United States moves to the left of
Point B along its PPF, the relative cost of computers
continues to fall until the United States totally
specializes in computers.
Both countries can attain consumption points that are
superior to those attained in the absence of trade.
3.4 Economies of Scale, Imperfect Competition, and
International Trade

In monopolistic competition models, two key
assumptions are made to get around the problem
of interdependence.
First,
each firm is assumed to be able to differentiate
its product from that of its rivals.
Second, each firm is assumed to take the prices
charged by its rivals as given.
3.4 Economies of Scale, Imperfect Competition, and
International Trade
Average Cost,
AC and Price, P
CC
AC3
P1
E
P2, AC2
AC1
P3
PP
n1
n2
n3
Number of
Firms, n
Equilibrium in Monopolistically Competitive Market
3.4 Economies of Scale, Imperfect Competition, and
International Trade

The number of firms in a monopolistically
competitive market, and the prices they charge,
are determined by two relationships.
On
one side, the more firms there are, the more
intensely they compete, and hence the lower is the
industry price. This relationship is represented by PP.
On the other side, the more firms there are, the less
each firm sells and therefore the higher is its average
cost. This relationship is represented by CC.

The equilibrium price and number of firms occur
when price equals average cost, at the intersection
of PP and CC.
3.4 Economies of Scale, Imperfect Competition, and
International Trade

Monopolistic Competition and Trade
The
number of firms in a monopolistically competitive
industry and the prices they charge are affected by the
size of the market.
In larger markets there usually will be both more firms
and more sales per firm; consumers in a large market
will be offered both lower prices and a greater variety
of products than consumers in small markets.
3.4 Economies of Scale, Imperfect Competition, and
International Trade
Average Cost, AC and Price, P
CC1
CC2
P1
1
2
P2
PP
n1

n2
Number of Firms, n
An increase in the size of the market allows each firm, given other things equal, to
produce more and thus have lower average cost. This is represented by a
downward shift from CC1 to CC2.The result is a simultaneous increase in the
number of firms (and hence in the variety of goods available) and a fall in the price
of each.
Chapter 3 Modern Trade Thoeries

3.1 Existence of Intraindustry Trade
 3.2 Technological gap, Product life Cycle and
International Trade
 3.3 Theory of Overlapping Demands
 3.4 Economies of Scale, Imperfect competition,
and International Trade
 3.5 Reciprocal Dumping
3.5 Reciprocal Dumping

In general, the practice of charging different
customers different prices is called price
discrimination.
 The most common form of price discrimination in
international trade is dumping, a pricing practice
in which a firm charges a lower price for exported
goods than it does for the same goods sold
domestically.
3.5 Reciprocal Dumping
Each firm has an incentive to “raid” the other market,
selling a few units at a price that is lower than the home
market price but still above marginal cost.
 If both firms do this, however, the result will be the
emergence of trade even though there is no initial
difference in the price of the good in the two markets and
there are some transportation costs.
 The situation in which dumping leads to a two-way trade
in the same product is known as reciprocal dumping.
