Chapter 5 Modern
International Trade Theory
制作人：刘继森教授
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1
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
O
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constant
Economies of scale
rise
Q
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
MC2
AC1
S2
AC2
P1
P2
LRAC
D1
O
Q1
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D2
Q2
Q
O
q
q1=q2
13
 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
P1=AC1
AC
MC
MR
O
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Q1
D
Q
20
 (B) monopolistic competitor
participated in international trade
P
P1=AC1
P2
AC
AC
D2
O
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Q1
MR1
MR2
D1
MC
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 shortterm 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
P1=LAC1
P3=LAC3
LAC
D3
MC
D1
O
MR1
Q1
MR3
Q3
Q
 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, intraindustry trade
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C,P
C,P
JAPAN
The U.S.
2.0
2.0
1.5
LAC
LAC
0
100
200
Export to the U.S.
Truck Q
0
100
Truck Q
JAPAN
C,P
C,P
The U.S.
2.0
2.0
1.5
LAC
LAC
0
100
Car Q
0
100 200
Export to Japan
Car Q
 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
P，MR
P，MR
MC，MR
MC
Pd
Pf
MCE
E
Ef
Ed
MRd+f
MRd
Qd
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Dd
MRf
Df
Q
Qf
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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
Pd> 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 intraindustry 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 intraindustry 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 intraindustry trade.
IIT  1 
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X M
X M
49
 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 lifecycle 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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Stage1
Stage 3
Stage 2
Q
Stage 4
Stage 5
export
C
p
export
Invent
country
c
p
Iimitate
country
import
0
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A
B
C
D
T
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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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 η = the percentage change in
demand on the A / the percentage in
income changes
 η> 1, the ratio of the increased
demand to A is over the ratio of the
increased income;
 η＜1， the ratio of the increased
demand to A is less than the ratio of
the increased income
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 η <0, income increased, consumer
demand for goods A reduced.
 According to value of income
elasticity of demand of goods,
economists divided goods as "luxury
items" (η> 1), "necessities" (1> η> 0)
and the "inferior goods "(η <0).
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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. Lindel’s
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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Q
P
H
G
B
F
E
D
A
C
O
yA
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yB
y
84
 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.
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