Recognize why international trade often occurs from increasing returns to scale and imperfect competition.
a. Trade can result from a tendency of unit costs to be lower with larger output.
b. Economies of scale give countries an incentive to specialize and trade even in the absence of differences between countries in their resources or technology.
c. Economies are more likely to give specialize because if they double their input of a product, they more than double their output giving them more of an incentive to devote more resources to that product. They can then trade any surplus of that product and import other products that they can no longer produce because more resources are being devoted to the product in which they have increasing returns to scale.
d. Economies of scale normally lead to a breakdown of perfect competition because firms have an incentive to produce more of a product with increasing returns to scale and therefore oligopolies and monopolies are more likely to occur. If there are only a few firms that produce a good in the world economy, there is a greater need to import that good in most parts of the world.
e. International trade allows creation of an integrated market that is larger than any one country's market, and thus makes it possible simultaneously to offer consumers a greater variety of products and lower prices.
International trade makes it possible for each country to produce a restricted range of goods and to take advantage of increasing returns to scale without sacrificing variety in consumption.
Understand the source of intra-industry trade and how it differs from inter-industry trade.
a. Interindustry trade is trade that exchanges the products of one industry for the products of another.
b. Intraindustry trade is the exchange of products within the same industry.
c. Intraindustry trade reflects economies of scale while interindustry trade reflects comparative advantage.
d. Intraindustry trade does not generate the same strong effects on income distribution as interindustry trade.
The relative importance of intraindustry and interindustry trade depends on how similar countries are. If Home and Foreign are similar in their capital-labor rations, the there will be little interindustry trade and intraindustry trade, based ultimately on economies of scale will be dominant. If the capital labor rations are very different, so for example one nation specializes completely in a given good, then there will be no intraindustry trade based on economies of scale. All trade will be based on comparative advantage.
Intraindustry trade plays a significant role in the trade in manufactured goods among advanced industrial nations, which accounts for most of world trade. It tends to be prevalent between countries that are similar in their capital-labor ration, skill levels, and so on (similar level of economic development). It is important because it allows countries to benefit from larger markets.
Detail the "dumping" arguments used by domestic industries as a basis for protectionism, and explain the relationship between dumping and price discrimination.
a. Dumping is a profit-maximizing strategy when export sales are more price-responsive than domestic sales, and when firms can effectively segment markets, that is, prevent domestic customers from buying goods intended for export markets.
b. Reciprocal dumping can be a cause of international trade.
c. Price discrimination is the practice of charging different customers different prices. Dumping is the most common form of price discrimination.
Dumping can only occur when:
1. the industry must be imperfectly competitive, so that firms set prices rather than taking market prices as given
2. Markets must be segmented so that domestic residents can not easily purchases goods intended for export.
Discuss the role of external economies and knowledge spillovers in shaping comparative advantage and international trade patterns.
a. External economies are economies of scale that occur at the level of the industry instead of the firm.
b. When external economies are important, a country starting with a large industry may retain that advantage even if another country could potentially produce the goods more cheaply.
c. When external economies are important, countries could conceivably lose from trade.
d. When there are external economies, firms will cluster together to draw from a shared worker pool (a process that benefits both employers and workers) and use the same specialized suppliers. However, when clustered together, there is a greater chance that knowledge will "spillover" to other firms especially through workers socializing with workers from other firms. The knowledge spillover takes the advantage away from the first firm to have the knowledge in question and puts all firms of that industry on the same plane.
A firm's cost divided by its output.
A pricing practice in which a firm charges a lower price for exported goods than it does for the same goods sold domestically.
Dynamic Increasing Returns
When costs fall with cumulative production over time, rather than with the current rate of production.
An approach by economists to model interregional and international trade, as well as such phenomena as the rise of cities, as different aspects of the same phenomenon - economic interaction across space.
External Economies of Scale
Occur when the cost per unit of a product of an economy of scale depends on the size of the industry and not necessarily on the size of any one firm.
Forward-Falling Supply Curve
Result of ignoring the imperfections in competition. Basically, the larger the industry's output, the lower the price at which firms are willing to sell their output.
Firms are aware that they can influence the prices of their products and that they can sell more only by reducing their price. It is characteristic both of industries in which there are only a few major producers and of industries in which each producer's product is seem by consumers as strongly differentiated from those of rival firms. Each firm thereby views itself as a price setter.
Infant Industry Argument
An argument for temporary production of industries to enable them to gain experience. It essentially protects the industry until it can stand on its own feet.
Trade for an item in one industry for an item in another (Example = cloth for food). This trade reflects comparative advantage.
Internal Economies of Scale
Occurs when the cost per unit depends on the size of an individual firm but not necessarily on that of the industry.
Trade that takes place between regions within countries.
The exchange of clothe for cloth for example. An exchange within that same industry. This trade does NOT reflect comparative advantage.
Informal diffusion of knowledge among different firms of an industry, usually located in a small area, where technology is passed from one firm to another either through "reverse engineering" and informal discussion among workers in the industry.
Labor Market Pooling
When a cluster of firms can create a pooled market for workers with highly specialized skills. It is to the advantage of both the producers and the workers as the producers are less likely to suffer from labor shortages, while the workers are less likely to be unemployed.
Downward sloping curves that relate unit cost to cumulative output and show how external economies of scale arising from the accumulation of knowledge differ from other external economies.
The amount that it costs a firm to produce one extra unit of a product.
Extra revenue that a firm gains from selling an additional unit. Always less than the price for a monopolist because to sell an additional unit the firm must lower the price of all units. It always lies below and corresponds to the demand curve.
Situation in which each firm is assumed to be able to differentiate its product from that of its rivals and each firm is assumed to take the prices charged by its rivals as given. Also known as oligopoly (defined below).
Economic structure in which there are several firms, each of them large enough to affect prices, but none with an uncontested monopoly.
The practice of charging different customers different prices (one example is Dumping which is defined above).
The simplest imperfectly competitive market structure. It is a market in which a firm faces no competition.
A situation in which dumping leads to two-way trade in the same product.
When a localized industrial cluster forms to bring together many firms that collectively provide a large enough market to support a wide range of suppliers that provide specialized equipment or support services that an individual company would not provide a large enough market for alone.