Question

Which trade theory can we explain developed economies like Uk, Germany by new trade theory or neoclassical trade theory? how about developing economies like Bangladesh?

Answer 1

Understanding Neoclassical Economics

The term neoclassical economics was coined in 1900. Neoclassical economists believe that a consumer's first concern is to maximize personal satisfaction. Therefore, they make purchasing decisions based on their evaluations of the utility of a product or service. This theory coincides with rational behavior theory, which states that people act rationally when making economic decisions.

Further, neoclassical economics stipulates that a product or service often has value above and beyond its production costs. While classical economic theory assumes that a product's value derives from the cost of materials plus the cost of labor, neoclassical economists say that consumer perceptions of the value of a product affect its price and demand.

Finally, this economic theory states that competition leads to an efficient allocation of resources within an economy. The forces of supply and demand create market equilibrium.

In contrast to Keynesian economics, the neoclassical school states that savings determine investment. It concludes that equilibrium in the market and growth at full employment should be the primary economic priorities of government. So this is the theory points the developed countries like Germany and UK

New trade theory also becomes a factor in explaining the growth of globalisation.

It means that poorer, developing economies may struggle to ever develop certain industries because they lag too far behind the economies of scale enjoyed in the developed world. This is not due to any intrinsic comparative advantage, but more the economies of scale the developed firms already have.

New trade theory (NTT) suggests that a critical factor in determining international patterns of trade are the very substantial economies of scale and network effects that can occur in key industries.

These economies of scale and network effects can be so significant that they outweigh the more traditional theory of comparative advantage. In some industries, two countries may have no discernible differences in opportunity cost at a particular point in time. But, if one country specialises in a particular industry then it may gain economies of scale and other network benefits from its specialisation.

Another element of new trade theory is that firms who have the advantage of being an early entrant can become a dominant firm in the market. This is because the first firms gain substantial economies of scale meaning that new firms can’t compete against the incumbent firms. This means that in these global industries with very large economies of scale, there is likely to be limited competition, with the market dominated by early firms who entered, leading to a form of monopolistic competition.

Conclusion

New trade theory is not primarily about advocating government intervention in industry; it is more a recognition that economies of scale are a key factor in influencing the development of trade. It also suggests that free trade and laissez-faire government intervention may be much less desirable for developing economies who find themselves unable to compete with established multi-nationals.