4 New trade theory

1.       No returns to scale, size does not matter neither for specialization nor for the direction of trade

—> we observe increasing returns to scale (economies of scale)

2.       Perfect competition, trade does not increase competition

3.       They predict exchanges of different goods between different countries

• scale effects

• pro-competitive effect: increase of competition, decrease of prices

• Rationalization effect: selection within the industry

• Variety effect: more varieties available for consumption

• External economies of scale may result if a larger industry allows for more efficient provision of services or equipment to firms in the industry.

• Internal economies of scale result when large firms have a cost advantage over small firms, causing the industry to become uncompetitive.

1. 1 good, several varieties horizontally differentiated w/o quality-differences

2. Internal increasing returns + no differentiation cost —> each producer is in monopoly on its variety

3. Free entry in the industry —> long run equilibrium w/ large no. of firms, each making zero profit = perfect competition

4. but price > marginal cost: operating profits just sufficient to cover fixed cost

By having fixed production cost

• Consumers benefit from increased variety

• In equilibrium, and assuming all firms have same demand and cost functions:

Autarky equilibrium

1. Supply condition: Average cost

F = fixed cost, c = marginal cost

1. Demand conditions & profit maximization yield:

—> markup over MC: decreasing function of no. of competitors

1. Zero profit in equilibrium requires P = AC

• 2 identical countries open up to reciprocal trade:

  • size of market x2

  • no. of firms x2

• higher competition —> price war

• All firms lose

  • no. of firms decreases

  • size of firms increases

Effects of trade:

• Lower price for each variety

• Larger no. of available varieties in each country

  • Global no. of varieties produced decreases

  • Uniformization process through trade

• More efficient scale of operation for all surviving firms

• Reallocation of resources within each industry: fewer firms, but each surviving is larger

• Net effect only, we do not observe which firms exit

1. Gains from inter-industry trade reflect comparative advantage

2. Gains from intra-industry trade reflect economies of scale (lower costs) and wider consumer choices

3. monopolistic competition model does not predict in which country firms locate, but a comparative advantage in producing the differentiated good will likely cause a country to export more of that good than it imports

4. Countries with similar / different relative amounts of factors of production are predicted to have intra / inter-industry trade

5. Unlike inter-industry trade in the Heckscher-Ohlin model, income distribution effects are not predicted to occur with intra-industry trade