Summary Extra Reading for Models in Part 2 of International Economics
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Course
International Economics (ECO00009H)
Institution
The University Of York (UOY)
In this document, I summarised the most important parts I found in the papers referenced in the lectures. I looked through the textbook all year round but found the more specific papers so much more useful in the revision for the exam. If you do not have time to read them all, I provided the 2 most...
Ricardian Trade Model: Eaton and Kortum (2012). “Putting Ricardo to
Work”, JEP
When presented with the opportunity to trade, countries benefit by
specialising in the activities they do relatively better Eaton and Kortum
(2012).
David Ricardo (1817) provided a mathematical example showing that
countries could gain from trade by exploiting innate differences in their
ability to make different goods. In the basic Ricardian example, two
countries do better by specialising in different goods and exchanging
them for each other, even when one country is better at making both.
This paper critically examines the Ricardian model and suggests that
today, the model needs to be augmented and developed with specific
assumptions, endowments and competition because it hits a dead end in
its analysis. They reformulate this into a practical tool to apply the model
to actual world trade. They suggest that adding more countries and
goods will move the model closer to reality. They also displayed in figure
2 how a positive change in the level of productivity expands the share of
goods a country produces. Applying the tool they managed to measure
gains from trade for different OECD countries in 2006 and found that
gains from trade were substantial, particularly for small countries. For
example over 25% of income for Denmark, Estonia and Hungary. For
the largest countries, Japan and the US, gains from trade amounted to
2-3% of GDP 20 years ago (around 1990s). But those gains are now
over 50% higher. This concludes that globalisation is beneficial for all
countries as stated in the theory of the Ricardian model.
Monopolistic Competition and Heterogenous firms: Melitz and Trefler
(2012). “Gains from Trade when Firms Matter”, JEP.
The rising prominence of intra-industry trade and huge multinationals
has transformed the way economists think about the gains from trade
(Melitz and Trefler, 2012).
, Today we focus on 3 sources of gains from trade:
1) Love-of-variety gains associated with intra-industry trade.
2) Allocative efficiency gains associated with shifting labour and
capital out of small, less productive firms and into large, more
productive firms.
3) Productive efficiency gains associated with trade-induced
innovation.
In the 1980s, a ‘New trade theory’ was developed that focused on intra-
industry trade in differentiated goods produced subject to increasing
returns to scale. This theory centred on an elegant tension: consumers
love variety and are willing to pay a premium for a desired product, but
as the market fragments into niche products, producers struggle to attain
the volumes needed to recoup their product development costs.
International trade creates a larger marketplace, which means that each
firm can operate at a larger scale and hence more firms can survive.
Paul Krugman earned the nobel prize in 2008 in large part for his work
highlighting how economies of scale and product differentiation lead to
intra-industry trade. (Krugman,1980)
A second source of gains from trade emerged from the research of
Melitz (2003) and Bernard, Eaton, Jensen, and Kortum (2003). This is
the firm-level ‘reallocation’ effect that arises when there is firm
heterogeneity. By firm heterogeneity we mean that even within narrowly
defined industries some firms are much larger and more profitable than
others because, for example, they are much more productive.
Globalisation generates both winners and losers among firms within an
industry and these effects are magnified by heterogeneity. Better-
performing firms thrive and expand into foreign markets, while worse
performing firms contract and even shut down in the face of foreign
competition. This generates a new source of gains from trade: as
production is concentrated towards better-performing firms, the overall
efficiency of the industry improves.
For Monopolistic competition:
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