GRA 6649International Economics

Lecture 8Associate professor Per Botolf Maurseth

Per.B.Maurseth@bi.no

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Lecture plan

Outline

• Taking stock– Trade between rich countries– Intra industry trade

• Increasing returns and monopolistic competition

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Outline – rest of the course• Lecture 8: Increasing returns and monopolistic competition

• Lecture 9: Increasing returns and monopolistic competition - continued

• Lecture 10: Economic Geography

• Lecture 11: Economic Geography

• Lecture 12: The gravity equation

• Lecture 13: Open

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Why is there so much trade between US and other rich countries?

• Factor content is similar? HOS cannot predict this trade.• Much trade is intra-industry, i.e. trade within commodity groups. • Standard measure of IIT: The Grubel-Lloyd index

• Gi = 2 min (EXPi, IMPi)/ (EXPi+ IMPi)

• or

• Gi = 1 – |(EXPi- IMPi)|/ (EXPi+ IMPi)

• for sector i.• A related measure is the net export ratio

• Bi = (EXPi- IMPi)/ (EXPi+ IMPi)

• since Gi = 1 - |Bi|

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• G = 1 – i |(EXPi- IMPi)|/ i (EXPi+ IMPi)

•  

• The index can be applied to a country’s trade with all partners, or bilaterally. It will normally lower in the latter case. For example, assume that Norway exports good X to Germany and imports it from France. If IIT is calculated for Norway’s total trade in X (with all partners), trade with Germany and France would, taken together, represent intra-industry trade, whereas in bilateral IIT measures it would not.

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• Some stylised facts on IIT:• It varies across sectors, and is higher for skill-intensive sectors. It is

not positively correlated with measures of economies of scale in production (some results show a negative correlation).

• It is higher in the trade of rich countries, and between rich countries. • It is higher between countries at similar income levels.• It falls with the distance between countries.• For many EU countries, more than 60% of trade is IIT.• Norway has low IIT, around 1/3 (based on 8-digit HS).• Oligopoly/concentration: Mixed results as to whether IIT is higher in

sectors with high concentration.

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Trade is intra-industry:

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

1970 1975 1980 1985 1992

shar

e of

tot

al

Year

Intra-industry trade, world

Trade is intra-industry:

Increasing returns and monopolistic competition

• Increasing returns: cannot have perfect competition

• Monopolistic competition– Many varieties within a commodity group– Consumers have preferences for more

commodities (an approximation – could be many different consumers as well).

– Increasing returns: AC>MC– Free entry ensures zero profits

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Monopolistic competition

• Must put emphasis on consumers.

• This lecture: Dixit-Stiglitz preferences.

• Autarky market

• Next time:– Trade – Trade with transportation costs – home

market effect

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Literature:

• Lecture notes by Karen Helene Ulltveit-Moe.

• Lecture notes

• Krugman (1994) ch. 1 and 2

• Feenstra (2004) ch. 5

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