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International Trade & the World Economy;  Charles van Marrewijk. CHAPTER 10; INTRA - INDUSTRY TRADE. Introduction Measuring intra-industry trade Dixit-Stiglitz demand Demand effects; income, price elasticity , and price index Increasing returns to scale Optimal pricing and zero profits

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Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

CHAPTER 10; INTRA - INDUSTRY TRADE

Introduction

Measuring intra-industry trade

Dixit-Stiglitz demand

Demand effects; income, price elasticity , and price index

Increasing returns to scale

Optimal pricing and zero profits

Explaining intra-industry trade

An alternative interpretation: intermediate goods

Conclusions


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

CHAPTER 10; INTRA - INDUSTRY TRADE

Introduction

Measuring intra-industry trade

Dixit-Stiglitz demand

Demand effects; income, price elasticity , and price index

Increasing returns to scale

Optimal pricing and zero profits

Explaining intra-industry trade

An alternative interpretation: intermediate goods

Conclusions


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

Introduction

Avinash Dixit (1944 - )


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

CHAPTER 10; INTRA - INDUSTRY TRADE

Introduction

Measuring intra-industry trade

Dixit-Stiglitz demand

Demand effects; income, price elasticity , and price index

Increasing returns to scale

Optimal pricing and zero profits

Explaining intra-industry trade

An alternative interpretation: intermediate goods

Conclusions


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

Measuring intra-industry trade (= two-way trade in similar goods)

Use the Grubel-Lloyd (GL) index

to measure intra-industry trade:


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

Measuring intra-industry trade

Variations in extent of intra-industry trade


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

Measuring intra-industry trade

Increasing importance of intra-industry trade


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

CHAPTER 10; INTRA - INDUSTRY TRADE

Introduction

Measuring intra-industry trade

Dixit-Stiglitz demand

Demand effects; income, price elasticity , and price index

Increasing returns to scale

Optimal pricing and zero profits

Explaining intra-industry trade

An alternative interpretation: intermediate goods

Conclusions


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

And the utility function is:

Then, subject to the budget constraint;

the demand for a

variety, say j, is:

(discussed below)

Characteristic is the love-of-variety effect, e.g. if ci = c for all i:

Dixit-Stiglitz demand

If there are N (= ‘large’) different varieties of manufactures


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

CHAPTER 10; INTRA - INDUSTRY TRADE

Introduction

Measuring intra-industry trade

Dixit-Stiglitz demand

Demand effects; income, price elasticity , and price index

Increasing returns to scale

Optimal pricing and zero profits

Explaining intra-industry trade

An alternative interpretation: intermediate goods

Conclusions


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

Demand effects; income, price elasticity , and price index

  • Dixit-Stiglitz demand depends on:

  • The income level Iequiproportionally

  • The price charged by the producernegatively

  • A parameter  > 1= price elasticity of demand

  • The price index Ppositively

Demand for a variety rises if the general price level P increases;

Each producer ignores his own impact on this price level, which is reasonable if N is ‘large’ but not if N is ‘small’ (see next slide)


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

Demand effects; income, price elasticity , and price index


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

CHAPTER 10; INTRA - INDUSTRY TRADE

Introduction

Measuring intra-industry trade

Dixit-Stiglitz demand

Demand effects; income, price elasticity , and price index

Increasing returns to scale

Optimal pricing and zero profits

Explaining intra-industry trade

An alternative interpretation: intermediate goods

Conclusions


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

Increasing returns to scale (IRS)

If the production function requires a fixed labor cost f before production starts at variable labor cost m there are IRS:


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

CHAPTER 10; INTRA - INDUSTRY TRADE

Introduction

Measuring intra-industry trade

Dixit-Stiglitz demand

Demand effects; income, price elasticity , and price index

Increasing returns to scale

Optimal pricing and zero profits

Explaining intra-industry trade

An alternative interpretation: intermediate goods

Conclusions


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

Optimal pricing and zero profits

  • As a result of IRS each variety is produced by single producer.

  • This producer has market power and charges a monopolistically competitive price (determines the optimal price by MR = MC, taking the prices charged by the other firms [the price index P] as given).

  • Because the price elasticity of demand is constant (equal to the parameter ) the mark-up over marginal costs charged by the producer is also constant.

  • Firms will enter the market (producing new varieties) if profits are positive; they will exit if profits are negative.

  • The number of varieties N produced is therefore determined by the zero-profit condition.

  • In the Dixit-Stiglitz model the number of varieties N produced is proportional to the size of the economy as measured by the labor force


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

CHAPTER 10; INTRA - INDUSTRY TRADE

Introduction

Measuring intra-industry trade

Dixit-Stiglitz demand

Demand effects; income, price elasticity , and price index

Increasing returns to scale

Optimal pricing and zero profits

Explaining intra-industry trade

An alternative interpretation: intermediate goods

Conclusions


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

Explaining intra-industry trade


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

CHAPTER 10; INTRA - INDUSTRY TRADE

Introduction

Measuring intra-industry trade

Dixit-Stiglitz demand

Demand effects; income, price elasticity , and price index

Increasing returns to scale

Optimal pricing and zero profits

Explaining intra-industry trade

An alternative interpretation: intermediate goods

Conclusions


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

An alternative interpretation: intermediate goods; Krugman


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

An alternative interpretation: intermediate goods; Ethier


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

CHAPTER 10; INTRA - INDUSTRY TRADE

Introduction

Measuring intra-industry trade

Dixit-Stiglitz demand

Demand effects; income, price elasticity , and price index

Increasing returns to scale

Optimal pricing and zero profits

Explaining intra-industry trade

An alternative interpretation: intermediate goods

Conclusions


Introduction measuring intra industry trade dixit stiglitz demand

International Trade & the World Economy;  Charles van Marrewijk

Conclusions

  • Empirically observed prevalence of intra-industry trade (two-way trade in similar products) puzzled theorists.

  • Intra-industry trade is measured using the Grubel-Lloyd index.

  • Krugman uses Dixit-Stiglitz variety approach with monopolistic competition and IRS to explain intra-industry trade.

  • Trade extends the market and raises welfare through an increases of the number of varieties available (love-of-variety).

  • Alternative interpretation (Ethier) explains intra-industry trade through exchange of intermediate goods; increased specialization leads to positive production externalities.


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