New trade theory explained. how does �new trade theory� explain the patterns of international trade? 2022-10-09
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New trade theory is a branch of economics that attempts to explain the patterns of international trade and the underlying factors that drive it. It is a relatively recent field of study, having emerged in the late 20th century as a response to the traditional theory of international trade, known as the "classical theory."
The classical theory, which was developed in the 18th and 19th centuries, is based on the idea that countries trade with one another because they have different endowments of resources and technology. This means that countries will produce and export the goods and services that they are most efficient at producing, and import those that they are less efficient at producing. This theory is known as the "comparative advantage" theory, and it is still widely accepted today.
However, the classical theory has some limitations, particularly when it comes to explaining trade between developed countries with similar endowments of resources and technology. This is where new trade theory comes in.
New trade theory attempts to explain trade patterns by considering the role of increasing returns to scale, which refers to the idea that the cost of producing a good decreases as the volume of production increases. This can occur for a variety of reasons, such as economies of scale (where the cost per unit decreases as the volume of production increases) or learning by doing (where the cost of production decreases as workers become more efficient at producing a particular good).
New trade theory also takes into account the role of product differentiation, which refers to the idea that firms may produce slightly different versions of the same product in order to appeal to different consumers. This can create demand for the product in multiple countries, leading to international trade.
Another key aspect of new trade theory is the role of technology and knowledge in driving trade. Countries may trade with one another not only to access resources and raw materials, but also to access new technologies and knowledge. This can lead to the transfer of technology and knowledge between countries, which can have a significant impact on their economic development.
Overall, new trade theory provides a more nuanced view of international trade, taking into account the role of increasing returns to scale, product differentiation, and technology and knowledge. It helps to explain why countries may trade with one another even when they have similar endowments of resources and technology, and how trade can impact economic development.
7 Main Theories of International Trade (Explained)
The equation written above has immense significance in the context of the accrual of internal economies of scale. In the conventional 2×2 setting, this means that country 1 imports one commodity, say commodity A, and exports the other commodity B, while country 2 imports B and exports A. While export-oriented companies usually support protectionist policies that favor their industries or firms, other companies and consumers are hurt by protectionism. These similarities have led to an increase in trade. In practice, governments and companies use a combination of these theories to both interpret trends and develop strategy.
Product Life Cycle Theory One can find this theory in almost every college textbook. A modern, firm-based international trade theory that explains intraindustry trade by stating that countries with the most similarities in factors such as incomes, consumer habits, market preferences, stage of technology, communications, degree of industrialization, and others will be more likely to engage in trade … What does the new trade theory of international trade explain about the international trade? By contrast, with NTT, we know more than just geography guides which goods are purchased. However in reality, these assumptions are hardly satisfied. Country 1 will then appear as an importer and exporter of the same commodity. New Trade Theory of International Trade takes a different approach from the New Trade Theory of International Trade noted that the existence of economies of scale makes large firms to be more efficient than small firms, and the industry may consist of a monopoly or a few large firms. Even as the consumer enjoys greater variety, the process actually decreases the variety of goods around the world, as certain brand names become staples of the worldwide economy. Not because of any particular intrinsic benefit but new firms start to get the network benefits of being around other IT setups.
how does �new trade theory� explain the patterns of international trade?
Both of these categories, classical and modern, consist of several international theories. Her productivity and income will be highest if she specializes in the higher-paid legal services and hires the most qualified administrative assistant, who can type fast, although a little slower than Miranda. With the increased production, prices would fall as a result of economies of scale. Trade will occur in goods that have overlapping demand, meaning that consumers in both countries are demanding the particular items. One needs to take note of the fact that in doing so, theorists borrowed heavily from industrial economics. The competition takes place. Main idea: countries will tend to export those kinds of products for which they have relatively large domestic demand.
The Heckscher-Ohlin model is an economic theory that proposes that countries export what they can most efficiently and plentifully produce. What is true of the relationship between trade and economic growth? Capital intensive means are assumed. In the final diagnosis, the PCT advocates a dynamic comparative advantage because the country source of exports shifts throughout the life cycle of the product. This comparative advantage meant that each country was always positioned to produce a particular good or service more efficiently than other competitors. This also implies that the aggregate preferences are the same. Such an integrated approach that embraced various individual efforts and synergized them into not one but rather many theories with different assumptions and consequently different results came into existence only in the 1980s. The horizontal and vertical axes show the consumption of a typical good by any representative consumer in the economy, that is, per capita consumption, c and the ratio between the price of the good and the wage rate, respectively.
Ricardo suggests while producing the costs should be checked carefully and compared and then the product asking comparatively less cost should be produced. Another notable emphasis is increasing returns to scale, whereby a firm can incur lower production costs by producing more of a particular variety, hence gaining market competitiveness. The second main characteristic of the Krugman model is the existence of the market structure of monopolistic competition. It is important to note that both countries have similar advantages in producing that particular good. In addition, there is a growth in foreign demand, but is associated particularly with other developed countries, since the product is catering to high income demands.
This section has sought to highlight the basics of international trade theory to enable you to understand the realities that face global businesses. These are: i The explanation of intra-industry trade ii The use of non-constant returns to scale. Linder suggests that the companies first produce for the domestic market. At the same time, network effects arise from the increasing demand base provided by international trade. As firms compete for the same market, they would produce more. Smith offered a new trade theory called absolute advantage, which focused on the ability of a country to produce a good more efficiently than another nation. Which is a feature of new trade theory? At the same time, there is a more extensive consumer base for such variety.
In learning to be frugal with our money, it may be that a free market will be attainable without legal trade sanctions. Firms will encounter global competition in their industries and in order to prosper, they must develop competitive advantages. Do these changes have a positive impact on the world economy? We have cars made in the United States, yet we purchase many cars made in other countries. These theories have some interesting implications for the developing countries. Both theories assumed that free and open markets would lead countries and producers to determine which goods they could produce more efficiently. To identify this, Porter lists four determinants. This, in turn, prevents perfect competition, and leads to fewer firms and greater output.
Evaluating trade at the level of the firm implies that overcoming firm-level fixed costs of trade and reducing uncertainty lead to increased trade along margins that generate the highest productivity, innovation and welfare gains. So there is a manmade improvement on the front of the real income of workers as well. It underlines that perfect competition does not exist, and imperfect competition takes over the same competition. Formaini, in Economic Insights Vol. It assumes trade happens equally irrespective of the economy or technology used between the nations. David Ricardo: Theory of Free International Trade by Robert L.
The theory may be illustrated using the following example. Whereby the network effect arises from the increasing demand for particular goods created by international trade. The theories covered in this chapter are simply that—theories. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations London: W. Leontief found that the US, which has an abundance of capital, should export capital goods and import labor-intensive goods.
Later, the economists found that labor in the US was more productive and in steady supply. New trade theory NTT refers to modern economic theory that explains international trade based on economies of scale, network effects, and first-mover advantage. In conclusion, these international trade theories are all about how to gain a sustainable competitive advantage over other firms in the same, or similar, industries. What is trade explain the importance of international trade? Even though countries may have no particular disadvantage in producing a particular type of good, they may still import this good from another country. Graph illustrating Krugman's 'core-periphery' model. The H-0 Theory is also known as the Modern Theory or the General Equilibrium Theory.