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Welcome to Econ 414 International Economics

Study Guide

Week Five

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Definitions (Chapter 4)

• Intra-industry trade: Export and import within the same industry or product group.– Example

• Inter-industry trade: Some industries export and others import.– Example

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Can factor proportions theory explain the Intra-industry trade?

• No–Because that implies that a nation

has comparative advantage as well as comparative disadvantage in production of the same product

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What is the Intra-industry Trade Index?

• It is used to compare different industries based on their amount of intra-industry trading

X-MIntraindustry Trade Index=1-

X+M X value of exports M value of imports

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• Example–US imports $100,000 worth of autos

and exports 30,000 worth of autos. What is ITI in the US auto industry?

–ITI = 1- (70,000/130,000) = 0.46

X-MIntraindustry Trade Index=1-

X+M

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• What if ITI was zero?– Country is either only exporting or only

importing– No intra-industry trade

• How can ITI be 1?– The country’s exports = its imports– 100% intra-industry trade

X-MIntraindustry Trade Index=1-

X+M

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Weaknesses of ITI

• Values of intraindustry trade depend on how a particular industry or product group is defined.

– More broadly defined groups will show more intraindustry trade.• Example: pants

– More narrowly defined groups will show less intraindustry trade.• Example: dress pants and jeans

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Definitions

• Homogenous goods are those that are identical (consumers can not differentiate between them) – Examples: apples, oranges

• Differentiated goods are those that are similar but not identical– Examples: toothpaste, cars

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Why is there intraindustry trade in homogeneous goods?

1. Location Transportation cost

• It is cheaper for City X to import cement from County A than buy it from City Y

• City Y will exports cement to Country C• B imports and exports cement

Country A

Country BCounty

CCity X

City Y

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Why is there intraindustry trade in homogeneous goods?

2. Joint products• Country A imports goods + insurance

(service)

• Country A exports other goods + insurance (service)

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Why is there intraindustry trade in homogeneous goods?

3. Entrepot trade– A computer producer in country X has a

worldwide distribution center in country Y

Country X Country

Y

Y imports and

exports the same computer

s

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Why is there intraindustry trade in homogeneous goods?

4. Re-export trade.– Goods are imported into a country,

and sometime later the same goods are subjected to a small transformation and exported to another country.• Example: Goods are imported, sorted,

repackaged and exported to another country to the Far East.

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Explanations of Intraindustry Trade in Homogeneous Products

5. Seasonal items Country A may only produce

strawberries in summer• Export strawberries in summer

• Import strawberries in winter

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Types of differentiated products

1. Horizontally differentiated products have the same price but slightly different characteristics

– Examples?• Candy bars

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Types of differentiated products

2. Vertically differentiated products have different prices and different characteristics–Examples?

• autos

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Why would a nation export and import differentiated goods?

• Price differentials (vertically differentiated products)

– Economies of scale• What is it?• Average cost goes down as you increase

production– Specialization

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Why would a nation export and import differentiated goods?

Example Compact cars are popular in JapanJapan increases its production of compact carsAverage cost of producing compact cars

declines in JapanJapan gains a comparative advantage in

production of compact carsJapan exports compact cars

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Why would a nation export and import differentiated goods?

Big cars are popular in the US

US increases its production of big cars

Average cost of producing big cars declines in US

US gains a comparative advantage in production of big cars

US exports big cars

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The Product Cycle Model

• Explains why we may turn from exporting a product to importing that product over time.

• From the time a new high tech product is developed to the time in becomes widely popular, it goes through 3 stages

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Example

• Stage 1 – Computers are just introduced to the market

in the US– They are expensive– Need high-income markets – R&D and production improvements require

highly skilled workers.– US may export computers to other

developed countries

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Stage 2

• Production of computers becomes more standardized.

• Production may move to other developed countries instead of exporting to those countries.

• US may begin to import computers from the new production country.

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Stage 3

• Production of computers has become standardized enough that move process to developing countries to utilize unskilled labor to lower costs.

• US becomes importer.

• US moves production focus to new products and cycle starts over.

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The Product Cycle Model

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The theory of overlapping demands

• Domestic producers produce goods targeted at tastes and income levels of the domestic market.

• Goods are exported to other countries with similar tastes and income levels.

• Linder states that high-income countries will trade with other high-income countries since income determines general tastes/preferences.

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The Welfare Implication of Intraindustry Trade

• Welfare is improved from increased choice and competition.

– Prices tend to be lower with trade in differentiated products.

– Quality tends to be higher.

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The Welfare Implication of Intraindustry Trade

• Reduces monopoly power of domestic firms

• Firms can produce at higher levels realizing economies of scale leading to lower prices.

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The only assignment this week

• Is to study Chapter 4 and discuss your questions/problems