Understanding Trade Theories and Market Structures

Key Concepts in International Trade Economics

Market Structures Comparison

Oligopoly vs. Monopolistic Competition

• Oligopoly: Refers to a market dominated by a small number of firms, where each firm formulates its strategy based on anticipated actions of the others.
• Monopolistic Competition: Refers to firms that possess brands granting them a degree of monopoly power, but they compete against other firms offering differentiated products that are close substitutes.

Production Location Decisions

Outsourcing and Offshoring

• Outsourcing: Production contracted to another firm, which may be located either inside the home country or abroad.
• Offshoring: Refers to relocating some or all production activities to a foreign country.

Trade Patterns

Interindustry vs. Intraindustry Trade

• Interindustry Trade: Involves the export and import of different types of products (e.g., the U.S. exports airplanes and imports wine).
• Intraindustry Trade: Involves the export and import of the same product category (e.g., Germany exporting cars and importing cars). This type of trade is common among high-income, advanced economies.

Factor Income and Price Changes

Derived Demand and The Stolper-Samuelson Theorem

• Derived Demand: The demand for factors of production (capital and labor) depends directly on the demand for the final goods they help produce, thus determining the income for their owners.
• Stolper-Samuelson Theorem: An increase in the price of a good raises the income of the factor used intensively in its production. Conversely, a decrease in a good's price lowers the income of the intensively used factor.

Trade Models Based on Scale

New Trade Theory: Internal and External Economies of Scale

• Models of trade based on economies of scale, both internal and external.
• Internal Economies of Scale: Occur when a firm increases its size, leading to a fall in its average cost of production.
• External Economies of Scale: Occur when an entire industry grows in size, causing the average cost of production to fall for individual firms within that industry.

Foreign Direct Investment Theory

OLI Theory

Explains why firms opt to invest abroad rather than simply engaging in trade:

• "O" (Ownership): Refers to the firm's unique assets or ownership advantages that make it competitive internationally.
• "L" (Location): Refers to a foreign location that offers specific advantages for production or sales.
• "I" (Internalization): Refers to the decision to manage the advantage internally (e.g., through Foreign Direct Investment) rather than licensing or subcontracting its use.

Factor Specificity in Trade

The Specific Factors Model

This model describes a situation involving three factors of production (land, labor, and capital), two outputs, where one factor is specific to the production of each output.

Trade Zones in Developing Nations

Export Processing Zones and Maquiladoras

A type of free zone established, generally in developing countries, to stimulate industrial and commercial exports.

• In the 1960s, Mexico implemented an Export Processing Zone (EPZ) policy, where plants were termed maquiladoras.
• These plants could be situated anywhere in the country and were permitted to import inputs duty-free, provided they exported the final output.