Hecksher Ohlin Trade Modelz

8/3/2019 Hecksher Ohlin Trade Modelz

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Selected Post-Heckscher-

Ohlin Trade Models

Appleyard & Field (& Cobb): Chapter 10

Krugman & Obstfeld: Chapter 6


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Todays Lecture

1. Economies of Scale (the Krugman model)

2. Domestic monopolies

3. Imitation Lag and The Product Cycle Model

4. The Linder Model5. Gravity Models

6. Geography and Trade


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The Krugman Model: Assumptions

1. Internal economies of scale

2. Monopolistic competition

(non-homogeneous goods)

3. One factor of production (labour)4. Identical preferences

5. Large number of goods produced with the

same technology

6. Full employment

Paul R. Krugman (1979): Increasing returns, monopolistic competition, andinternational trade.Journal of International Economics, Vol. 9(4): 469-479


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Key assumption 1: Economies of Scale

External: cost per unit depends on the size of the

industry, not the firm (Silicon Valley, Hollywood...) Internal: cost per unit depends on the size of the

firm, not industry(Nokia, Phillips, GE...)

o Krugman models technology: L=a+b*Q theamount of labour required (L) to produce amount of

input (Q) depends on b*Q andconstant a (fixed cost)

Doubling the inputs more thandoubles theoutput (increasing internal economies of scale)


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Production Possibilities Frontier with

Economies of Scale

Good Y

Good X


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Key assumption 2:

Monopolistic Competition

Each firm produces a different brand of the

good (goods that are not exactly the same, but that aresubstitutes for one another)

Each firm takes prices of rivals as given (=no

strategic pricing) Each firm behaves as if it were a monopolist

However, we assume easy entry and exit

zero-profits in the long runo as long as (average cost < price) more firms enter the

market


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Long-Run Market Equilibrium of

Monopolistically Competitive Market

The more firms there are:

1. the less each firmproduces higheraverage cost (due toincreasing returns to scale) upward sloping costcurve

2. the harder the

competition decreasingprice downwardsloping price curve

Price

Number of firms

AC

P

n*

p*


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Introducing Trade to the Monopolistic

Competition Model

Trade increases market size firms exploit more of thereturns to scale average costdecreases price decreasesnumber of firms increases

i.e. a larger variety of products isavailable for smaller price

everybodyare better off even if

the countries are identical

Price

Number of firms

ACA

P

nA

pA

nFT

pFT

ACFT


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Intra- and Inter-industry Trade Inter-industry trade: countries export goods of one

product category and imports goods of other productcategory as in the Ricardian as well as in theHeckscher-Ohlin modelo e.g. Finland exports capital-intensive and imports labour

intensive goods Intra-industry trade: countries export and import

products of the same products category as in theKrugman modelo e.g. the U.S. exports and imports carso constitutes about of the world trade


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Explaining Trade Patterns

Inter-industry trade reflects the comparative

advantageo the pattern of trade is determined by relative factor

endowments / technological differences

Intra-industry trade reflects economies of scaleo the pattern of trade is unpredictable

The relative importance of the two kinds of tradedepend on how similar the countries are


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Other Explanations of Intra-Industry Trade

Transport costs in large countries (e.g. a buyer in Maine

buys the Canadian rather than the Californian product) Dynamic economies of scale: product differentiation +

learning-by-doing

Problems with statisticso Aggregation: the categories are too wide (e.g. beverages

and tobacco)

o Different quality of goods inside a product category


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Domestic monopolies

Domestic monopoly entering world markets

Single monopoly & price discrimination

Two domestic monopolies entering world

markets (reciprocal dumping model)


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Domestic Monopoly Entering World Markets

Price

Quantity

D

MC

MRA

QA QT

exports

Pint

PAPD

MRT

QD

Domestic monopoly is able to get

Pint from the world market

Pint = minimum marginal revenue

The monopolists

maximizes profits

by selling QD at

home for price PDand QT-QD

abroad for Pint


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Single world supplier:

Price Discrimination

Quantity

P

rice

Quantity

Price

Country 1

MC

D1MR1

MR2

D2

Country 2

Profit maximizing monopolist,

constant marginal cost, separate

markets and a more price-elastic

demand in country 2

P1

P2

P1>P2


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Dumping One of the most heated & active debates on trade concerns dumping.

Roughly, this means that domestic producers complain that foreign

competitors are selling at unfairly low prices and hence there should beantidumping measures (tariffs/quotas). There are (at least) two definitions

what dumping means:

o Economics definition: Price discrimination in the

context of international trade (a firm is charginglower/higher price for its exports)

o Pragmatic (lawyers) definition: the price is less than

production cost.This could be an indicator ofpredatory pricingwhere the aim is to drive the domestic competitor out of the market and

afterwards the foreign firm would use its monopoly power and increase

prices (and hence hurt the consumers).


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Reciprocal Dumping Model Two countries, two firms producing identical

goods, transportation costs First, both are domestic monopolies

Then, both enter each others markets

duopoly (two firms taking into account the behaviour of eachother when choosing prices and quantities)

In the (Nash) equilibrium price and output are determined in each

market for each firm (getting the result requires some knowledge ofgame-theory, so we will not derive it here)

The point is that the price is different in home andforeign markets (hence dumping)

Brander (1981): Intra-Industry Trade in Identical Commodities. JIE 11(1)

Brander & Krugman (1983): A Reciprocal Dumping Model of International Trade. JIE 15(3/4)


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Imitation Lag Assume that it takes time for new technology to spread

Imitation lag: the time between products introduction incountry 1 and appearance of a version of that product produced

in country 2

Demand lag: time between products appearance in country 1

and its acceptance in country 2

Net lag: imitation demand lag

Trade focuses on new products


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The Product Cycle Theory The product cycle consists of three stages (new,

maturing, standardized)

1. A new product is introduced in a rich countryo High-income demands, labour-saving production

technique

o The firms operate only in the domestic markets and learnproduction techniques and consumer responses

2. Maturing producto Economies of scale start to realize

o Demand in other rich countries starts to emerge

o Part of the production may be shifted to these countriesand they might even start exporting to the original country


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The Product Cycle Theory

3. Standardizedproduct

o Product is well know

to consumers andproducer

o Production may shift

to the developing

countiestime

Production, consumption

(in the developed country)

exports

imports

new product

stage

maturingproduct

stage

standardizedproduct

stage

Consumption1

Production1

Vernon (1966): International InvestmentAnd International Trade in the Product

Cycle.Quarterly Journal of Economics80(2).


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Dynamic Comparative Advantage Dynamic comparative advantage: source of

exports shift throughout the life cycle of thegood (e.g. electronics, cars)

Resulting from economies of scale, factor

mobility and innovation


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The Linder Model Demand-oriented model to explain trade in

manufactured goods Preferences depend on the level of income

tastes yield demands for products demands lead to

production the kinds of goods produced depend onthe per capita income level of a country

Trade occurs if there is overlapping demand

Trade will be more intense the more

similar the countries are


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The Linder Model: Example

Let A be the lowest quality and J

the highest quality good Let country 1 be the poorest and

country 3 the richest (see graph)

Then country 1 consumes andproduces goods AD, country 2

goods CF and country 3 good EJ

Countries 1 and 2 may trade goodsC,D; countries 2 and 3 may tradegoods E,F and countries 1 and 3

have no basis for tradeIncome

levels

Goods

S.B Linder (1961): An Essay on Trade

and Transformation. John Wiley & Sons.

A

B

C

D

EF

G

H

J

Country 1

Country 2Country 3


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Gravity Models Focus to explain thevolume (not the composition) of

trade between two countries Popular framework in econometrics: Typically the

volume of exports and imports is modelled as a

function of countries national incomes, distance andother observable characteristics such as population size

and institutional dummies (e.g. free trade area)


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Geography and Trade Firms decide the location of production in the

presence ofo economies of scale rationale for concentrating

production, imperfect competition

o transportation cost rationale for decentralizing

production Dynamic comparative advantage may be based oncoincidence that has set off a cumulative process

Trade often takes place as a result of arbitrary

specialization based on increased returns Policies may influence the beginning of such an

cumulative process

P. Krugman (1991): Geography and Trade. MIT Press.


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Basis for Trade Comparative Advantage

o Technology (Ricardian Model)

o Factor endowments (Heckscher-Ohlin Model)

Internal economies of scale (Krugman Model) Dynamic Comparative Advantage

o Innovation and product cycle

oCumulative process due to e.g. external economies of scale orlearning-by-doing


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Impact of Trade Ricardian Model

o

complete specializationo increase of countrys consumption possibilities

Heckscher-Ohlin Modelo shift of production towards commodity that uses

intensively countrys abundant factor of productiono real income of the abundant factor increases and the

real income of scarce factor decrease

o

increase of countrys consumption possibilities Krugman Modelo more firms and more varieties of goods

o lower cost of production lower price

Hecksher Ohlin Trade Modelz

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