NEW and (OLD NEW) TRADE THEORIES · Paper and paperboard, articles of pulp, paper and board 290031...

INTERNATIONAL ECONOMIC POLICY AND

DEVELOPMENTAA 2019-2020

PROF. PIERLUIGI [email protected]

NEW and (OLD NEW) TRADE THEORIES

Why countries trade

Unit : US Dollar thousand

Va lue in 2 0 11 Va lue in 2 0 12 Va lue in 2 0 13

TOTAL All products 48779200 48354852 47442249

'87 Vehicles other than railway, tramway 6721872 7297720 6051037

'90 Optical, photo, technical, medical, etc apparatus 5828342 5858626 5996439

'84 Machinery, nuclear reactors, boilers, etc 6039220 5894851 5884932

'88 Aircraft, spacecraft, and parts thereof 5674397 5656078 5809280

'85 Electrical, electronic equipment 4441704 4176456 4265620

'30 Pharmaceutical products 2515682 2561810 2208824

'71 Pearls, precious stones, metals, coins, etc 1806466 1487383 1984524

'38 Miscellaneous chemical products 1503566 1458161 1580185

'99 Commodities not elsewhere specified 1448146 1389431 1360073

'29 Organic chemicals 1337973 1357339 1288524

'39 Plastics and artic les thereof 1308694 1196360 1188499

'27 Mineral fuels, oils, distillation products, etc 1350587 1054978 863414

'12 Oil seed, oleagic fruits, grain, seed, fruit, etc, nes 352425 940514 812558

'08 Edible fruit, nuts, peel of c itrus fruit, melons 434239 466485 649739

'70 Glass and glassware 597946 540389 563711

'97 Works of art, collectors pieces and antiques 390647 363781 360520

'28

Inorganic chemicals, precious metal compound,

isotopes 565399 440523 343005

'73 Artic les of iron or steel 346606 343240 334642

'33 Essential oils, perfumes, cosmetics, toileteries 283269 314646 321851

'03 Fish, crustaceans, molluscs, aquatic invertebrates nes 289951 284451 314551

'74 Copper and artic les thereof 274593 305286 301160

'47 Pulp of wood, fibrous cellulosic material, waste etc 292599 309415 270139

'40 Rubber and artic les thereof 332220 285797 270080

'48

Paper and paperboard, artic les of pulp, paper and

board 290031 269107 267940

'22 Beverages, spirits and vinegar 181023 184968 259122

Produc t c ode Produc t la be lUnite d Sta te s of Ame ric a 's e xports to Ge rma ny

USA's main exports to Germany

USA's main imports from GermanyVa lue in 2 0 11 Va lue in 2 0 12 Va lue in 2 0 13

TOTAL All products 100392798 110602812 116924737

'87 Vehicles other than railway, tramway 25005279 29992279 33168142

'84 Machinery, nuclear reactors, boilers, etc 20696991 22469147 22374261

'30 Pharmaceutical products 8509406 10185517 11174901

'90 Optical, photo, technical, medical, etc apparatus 8865467 8926945 9036842

'85 Electrical, electronic equipment 7657145 7849851 7808184

'99 Commodities not elsewhere specified 3212837 3492118 3717551

'29 Organic chemicals 2921629 3137577 3444239

'88 Aircraft, spacecraft, and parts thereof 1570659 1523341 2973561

'39 Plastics and artic les thereof 2306547 2504781 2643734

'73 Artic les of iron or steel 1646913 2156193 1913667

'38 Miscellaneous chemical products 1328337 1463370 1707361

'71 Pearls, precious stones, metals, coins, etc 1414710 903251 1209582

'40 Rubber and artic les thereof 1128266 1202111 1200480

'28

Inorganic chemicals, precious metal compound,

isotopes 1340807 1293421 1097083

'72 Iron and steel 1300607 1265146 1078080

'48

Paper and paperboard, artic les of pulp, paper and

board 936960 915384 835700

'97 Works of art, collectors pieces and antiques 462857 853995 834437

'82 Tools, implements, cutlery, etc of base metal 649169 737781 815718

'94 Furniture, lighting, signs, prefabricated buildings 600225 599737 677175

'74 Copper and artic les thereof 675953 646996 626613

'76 Aluminium and artic les thereof 675225 663743 619956

'32 Tanning, dyeing extracts, tannins, derivs,pigments etc 517686 566919 598737

'70 Glass and glassware 537270 546710 542178

'22 Beverages, spirits and vinegar 555586 487750 468667

'83 Miscellaneous artic les of base metal 391987 440838 466874

Produc t c ode Produc t la be lUnite d Sta te s of Ame ric a 's imports from Ge rma ny

The Ricardian model and the H-O model explain why countries

trade but do not predict the simultaneous import and export of

the same product

In those models, markets were perfectly competitive and goods

are homogeneous:

• many small producers of identical product not able to

influence the market price

To explain trade of the same product, we need to change those

assumptions

Why do countries export and import the

same goods and/or services?

The New Trade TheoryNew trade theory (NTT) is a collection of economic models in international trade -developed in the late 1970s and early 1980s -which focuses on the role of increasingreturns to scale.

“Thirty years have passed since a small group of theorists began applying concepts

and tools from industrial organization to the analysis of international

trade. The new models of trade that emerged from that work didn’t supplant

traditional trade theory so much as supplement it, creating an integrated

view that made sense of aspects of world trade that had previously posed

major puzzles. The “new trade theory” – an unfortunate phrase, now quite

often referred to as “the old new trade theory” – also helped build a bridge

between the analysis of trade between countries and the location of production

within countries”.

THE INCREASING RETURNS REVOLUTION IN TRADE AND GEOGRAPHY, Prize Lecture, December 8, 2008, Paul Krugman

The New Trade Theory

2 key assumptions:

Imperfect competition: monopolistic competition, duopoly,

oligopoly, where producers are able to exert some control

over the market price.

Differentiated goods: goods are differentiated, differently

from perfectly competitive markets where the goods

produced are homogeneous (identical).

Monopolistic competition: introduction

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers

Monopolistic competition has two key features:

• The goods produced by different firms are differentiated

(hence firms are able to exert some control over the price).

• Firms enjoy increasing returns to scale, by which we mean

that the average costs for a firm fall as more output is

produced . By selling not only in the home market but also in

the foreign market firms can increase their returns to scale

– Note: increasing returns to scale create a reason for

trade to occur when the countries are similar in their

technologies and factor endowments

– Intra-industry trade deals with imports and exports in

different varieties of the same type of product (i.e. in the

same industry)

• The monopolistic competition model assumes differentiated products, many firms, and increasing returns to scale. Firms enter whenever there are profits to be earned, so profits are zero in the long-run equilibrium.

• When trade opens between two countries, the demand curve becomes more elastic, as consumers have more choices and become more price-sensitive.

• Firms then lower their prices in an attempt to capture consumers from their competitors and obtain profits. When all firms do so, however, some firms incur losses and are forced to leave the market.

• Additional gains from trade:

• (i) lower prices as firms expand their output and lower their average costs;

• (ii) more imported product varieties available to consumers.

• There are also short-run adjustment costs, such as unemployment, as some firms exit the market.

Conclusion: The assumption of differentiated goods allows to understand why countries often import and export varieties of the same type of good.

K e y T e r m Model of monopolistic competition: KEY POINTS


The first 2 assumptions are about the demand facing eachfirm:

Assumption 1: Each firm produces a good that is similar to but slightly differentiated from the goods that other firms in the industry produce.

• Each firm faces a downward-sloping demand curve for its product and has some control over the price it charges.

Trade under Monopolistic Competition

Assumptions of the model of monopolistic competition:


Monopoly Equilibrium

FIGURE 6-1

Monopoly Equilibrium

The monopolist chooses

the profit-maximizing

quantity, QM, at which

marginal revenue equals

marginal cost.

From that quantity, we

trace up to the demand

curve and over to the

price axis to see that the

monopolist charges the

price PM.

The monopoly equilibrium

is at point A.

The extra revenue earned from

selling one more unit is called the

marginal revenue.

1 Basics of Imperfect Competition


Assumption 2: There are many firms in the industry

• If the number of firms is N, then D/N is the share of demand that each firm faces when the firms are all charging the same price.

• When only one firm lowers its price, however, it will face a flatter demand curve d.


Demand with DuopolyFIGURE 6-2 (1 of 2)

Demand Curves with Duopoly

When there are two firms in

the market and they both

charge the same price, each

firm faces the demand curve

D/2.

At the price P1, the industry

produces Q1 at point A

and each firm produces Q2 =

Q1/2 at point B.

If both firms produce identical

products and one firm lowers

its price to P2, all consumers

will buy from that firm only;

the firm that lowers its price

will face the demand curve, D,

and sell Q3 at point C.


Demand with DuopolyFIGURE 6-2 (2 of 2)

Demand Curves with Duopoly

Alternatively, if the products

are differentiated, the firm that

lowers its price will take

some, but not all, sales from

the other firm;

it will face the demand curve,

d, and at P2 it will sell Q4 at

point C′.


The 3th assumption is about each firm’s cost structure

Assumption 3: Firms produce using a technology with increasing returns to scale.

FIGURE 6-3

Increasing Returns to

Scale This diagram

shows the average

cost, AC, and marginal

cost, MC, of a firm.

Increasing returns to

scale cause average

costs to fall as the

quantity produced

increases.

Marginal cost is below

average cost and is

drawn as constant for

simplicity.



Numerical Example of Increasing Returns to ScaleTABLE 6-2

Cost Information for the Firm This table illustrates increasing returns to

scale, in which average costs fall as quantity rises.


Whenever the price charged is above average costs, then a firm

earns monopoly profits.


The 4th assumption is about profit:

Assumption 4: Because firms can enter and exit the industry freely, monopoly profits are zero in the long run.

• Firms will enter as long as it is possible to make monopoly profits, and the more firms that enter, the lower profits per firm become.

• Profits for each firm end up as zero in the long run, just as in perfect competition.




Next, we will examine monopolistic competition:

• in the short run

• in the long run


without trade

• in the short run

• in the long run with free trade

Short-Run Equilibrium

Equilibrium without Trade

FIGURE 6-4

Short-Run Monopolistic

Competition Equilibrium

without Trade The short-

run equilibrium under

monopolistic competition

is the same as a monopoly

equilibrium.

The firm chooses to

produce the quantity Q0 at

which the firm’s marginal

revenue, mr0, equals its

marginal cost, MC.

The price charged is P0.

Because price exceeds

average cost, the firm

makes monopoly profits.



Long-Run Equilibrium


FIGURE 6-5 (1 of 2)

Long-Run Monopolistic Competition


Drawn by the possibility of making

profits in the short-run equilibrium,

new firms enter the industry (drawing

demand away from existing firms and

producing more product varieties)

and the firm’s demand curve, d0,

shifts to the left and becomes more

elastic (i.e., flatter), shown by d1.

The long-run equilibrium under

monopolistic competition occurs at

the quantity Q1 where the marginal

revenue curve, mr1 (associated with

demand curve d1), equals marginal

cost.

At that quantity, the no-trade price,

PA, equals average costs at point A.



Long-Run Equilibrium


FIGURE 6-5 (2 of 2)Long-Run Monopolistic

Competition Equilibrium without

Trade

In the long-run equilibrium, firms

earn zero monopoly profits and

there is no entry or exit.

The quantity produced by each firm

is less than in short-run

equilibrium. Q1 is less than Q0

because new firms have entered

the industry.

With a greater number of firms and

hence more varieties available to

consumers, the demand for each

variety d1 is less then d0. The

demand curve D/NA shows the no-

trade demand when all firms

charge the same price.



Firm’s demand curve in the long-run (flatter than d0)(quantity demanded depending on the price charged by that firm)

Short-Run Equilibrium with Trade

Equilibrium with Free Trade


Assume Home and Foreign are exactly the same.

• Same number of consumers

• Same technology and cost curves

• Same factor endowments

• Same number of firms in the no-trade equilibrium

Given the above conditions, if there are economies of scale, there is reason for trade. Even two identical countries will engage in trade because increasing returns to scale exist.





• The number of firms in the no-trade equilibrium in each country is NA.

• When trade opens, the number of customers available to each firm doubles as does the number of firms

• Since there are twice as many consumers, but also twice as many firms, the demand curve is the same (2D/2NA=D/NA)).

• The product varieties also double.

• With the greater number of varieties available, the demand for each individual variety will be more elastic.

• If one firm drops its price below PA, it can attract a greaternumber of (Home and Foreign) customers away from otherfirms




FIGURE 6-6 (1 of 2)


Competition Equilibrium with

Trade

When trade is opened, the

larger market makes the firm’s

demand curve more elastic, as

shown by d2 (with

corresponding marginal

revenue curve, mr2).

The firm chooses to produce

the quantity Q2 at which

marginal revenue equals

marginal costs;

this quantity corresponds to a

price of P2 (point B). With sales

of Q2 at price P2, the firm will

make monopoly profits

because price is greater than

AC.





FIGURE 6-6 (2 of 2)



Trade

When all firms lower their

prices to P2, however, the

relevant demand curve is D/NA,

which indicates that they can

sell only Q′2 at price P2.

At this short-run equilibrium

(point B′), price is less than

average cost and all firms incur

losses.

As a result, some firms are

forced to exit the industry.



Long-Run Equilibrium with Trade



• Since firms are making losses, some of them will exit the industry.

• Firm exit will increase demand for the remaining firms’ products and decrease the available product varieties to consumers.

• We now have NT firms which is fewer than the NA firms we had before.

• The new demand D/NT >D/NA (because the reduction of firms increases the share of demand facing each one)


FIGURE 6-7 (1 of 2)

Long-Run Monopolistic


Trade

The long-run equilibrium with

trade occurs at point C.

At this point, profits are

maximized for each firm

producing Q3 (which satisfies

mr3 = MC) and charging price PW

(which equals AC).

Since monopoly profits are zero

when price equals average cost,

no firms enter or exit the

industry.





FIGURE 6-7 (2 of 2)

Long-Run Monopolistic


Trade (continued)

Compared with the long-run

equilibrium without trade, d3 has

shifted out as domestic firms

exited the industry and has

become more elastic due to the

greater total number of varieties

with trade..

Compared with the long-run

equilibrium without trade at

point A, the trade equilibrium at

point C has a lower price and

higher sales by all surviving

firms.





Gains from Trade


The long-run equilibrium at point C has two sources of gains from trade for consumers:

1. A drop in price:

The lower price is a result of increased productivity of the surviving firms coming from increasing returns to scale.

2. Gains from trade to consumers:

Although there are fewer product varieties made within each country (by fewer firms), consumers have more product variety because they can choose products of the firms from both countries after trade.




Adjustment Costs from Trade

• There are adjustment costs associated with monopolistic competition, as some firms shut down or exit the industry.

• Workers in those firms experience a spell of unemployment.

• Over the long run, however, we could expect those workers to find new jobs, so these costs are temporary.



Conclusions of the model

• When firms have differentiated products and increasing returns to scale, there is a potential for gains from trade that did not exist in earlier models.

• The model of monopolistic competition shows that trade will occur between countries even if these countries are identical.

• There is trade within the same industries across countries because there is a potential to sell in a larger market.

• This will induce firms to lower their prices below those charged in the absence of trade.

• As firms exit, remaining firms increase their output and average cost falls. Lower costs results in lower prices for consumers in the importing country.


Conclusions-2

• Lower prices and higher product variety are the gains from trade under monopolistic competition.

• However, since some firms exit the market, there are short-run adjustment costs due to worker displacement.


Why countries trade

A brief introduction to the New New trade theory:firms in international trade (or heterogeneous firms)

Firms in international trade

• Under Ricardian Model and H-O Model firms are blackboxes

• Under New trade theories: firms' dimension counts with increasing return to

scale, but all domestic firms will export afteropening up to trade;

there is a firm-exit effect, but it is indeterminatewhich firms exit the market

• Micro-level empirical evidence (see the many papersby Bernard, et al. starting in the mid-90s) show stylizedfacts unexplained under these theories

Firms in international trade -2

• Firms are very different in terms of productivity

• Only a minority of firms are exporters

• Usually exporters are more productive

• Exporting is characterized by fixed costs

What effects on gains from trade?

• Opening up to trade kicks out the least productive firms and enhances average productivity.

Hence, need a framework that could account for firms‘ heterogeneity

The “New” new trade theory

This framework is called the “New” new trade theory (or the theoryof heterogeneous firms)• Melitz (2003) constructed a model in which only a few highly

productive firms are engaged in export: these firms are able to make sufficient profits to cover the

large fixed costs required for export operations.

• Helpman et al. (2004) expanded the Melitz (2003) model intoone in which the productivity of exporting firms is lower thanthat of firms engaged in local production overseas (FDI). only productive firms can cover the enormous fixed costs

(local factory construction, etc.) entailed in local productionoverseas.

These "Melitz-type models" constituted the theoretical foundationsfor empirical research based in particular on firm-level data.

The “New” new trade theory -2

New source of trade gains:

• When lowered trade barriers stimulate competition on aglobal scale, low-productivity firms that had been protectedare forced to withdraw from the market, replaced by theincreased production volume of high-productivity firms.

• As a consequence, the average productivity of a country onthe whole rises. This rise in average productivity means a risein people's real income; people become wealthier throughthe natural selection of firms on a global scale.

NEW and (OLD NEW) TRADE THEORIES · Paper and paperboard, articles of pulp, paper and board 290031...

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