Intra-Industry Trade and New Trade Theory Quiz

6 Questions

Which two dominant trade theories could not explain the empirical regularities of trade in the 1970s?

Ricardian and Heckscher-Ohlin models

What is the definition of intra-industry trade (IIT)?

A situation where a country is both importing and exporting goods within the same product category

What is monopolistic competition?

A market structure that assumes each firm is able to differentiate its product from competitors and each firm is assumed to take the prices charged by its rivals as given

What are scale economies and how do they affect trade? Provide an example.

Scale economies refer to the situation where the (average) cost of production declines with the quantity produced. This means that larger firms have a cost advantage, which leads to a departure from perfect competition. In the context of trade, concentrating production in a single market leads to lower costs, making trade beneficial even if countries are identical. An example of scale economies in trade is the production of cars by a single car manufacturer in a specific country, which can lead to lower costs and increased efficiency.

What is intra-industry trade (IIT) and how is it difficult to reconcile with traditional trade theories?

Intra-industry trade (IIT) refers to a situation where a country is both importing and exporting goods within the same product category. This is difficult to reconcile with traditional trade theories based on differences in endowments or technology, such as the Ricardian and the Heckscher-Ohlin models, which both predict specialization rather than trade within the same industry.

How do trade costs and increasing returns to scale affect the home market effect in trade?

When trade costs are considered together with increasing returns to scale, countries will export goods for which they have a large domestic market. This is in contrast to previous theories where larger markets were associated with imports, not exports. This is known as the home market effect in trade.

Study Notes

Trade Theories and Intra-Industry Trade

In the 1970s, the two dominant trade theories, namely Ricardian and Heckscher-Ohlin, struggled to explain the empirical regularities of trade.
These theories failed to account for the phenomenon of intra-industry trade (IIT), which refers to the exchange of similar goods or services within an industry between countries.

Intra-Industry Trade (IIT)

IIT is a trade phenomenon where similar goods or services are exchanged between countries within an industry.

Monopolistic Competition

Monopolistic competition is a market structure characterized by many firms producing differentiated products, leading to a degree of monopoly power.

Scale Economies

Scale economies refer to the reduction in average costs of production as the output of a firm increases.
Example: An automobile manufacturer can reduce its average cost per unit by increasing production and spreading its fixed costs over a larger output.

Intra-Industry Trade and Traditional Trade Theories

IIT is challenging to reconcile with traditional trade theories because it involves the exchange of similar goods, contradicting the assumption of perfect substitution.

Trade Costs and Increasing Returns to Scale

Trade costs, including transportation and other costs, can affect the home market effect in trade.
Increasing returns to scale, resulting from scale economies, can also impact the home market effect, as firms can reduce their average costs and increase their competitiveness in the export market.