Question

Define the concept of intra-industry trade and explain briefly why increasing returns to scale in production, along with consumer tastes for variety in consumption, help explain this kind of trade.

Answer 1

Intra- Industry trade -

Intra - Industry trade refers to the exchange of similar products belonging to the same industry. The term is usually applied to international trade, where the same types of goods or services are both imported and exported.

Example- Example of this kind of trade include automobiles, foodstuffs and beverages, computers and minerals.

Europe exported 2.6 million motor vehicles in 2002, and imported 2.2 million of them. Japan exported 4.7 million vehicles in 2002 ( 1 million of which went to Europe, and 2 million to North America),and imported 0.3 million.

Explanation-

1- The traditional model of trade were set out by the model of David Ricardo and the Heckscher- Ohlin model, which tried to explain the occurrence of international trade

Both modeld used the idea of comparative advantage and an explanation of why countries trade .However, many economists have made the point of claiming that these models provide no explanation towards Intra- Industry trade as under their assumptions countries with identical factor endowments would not trade and produce goods domestically. Hence ,as intra- industry trade has developed many economists have looked at other explanations.

2- The large volume of intra- industry trade is often cited as a critical element favoring trade theories based on increasing returns and imperfect competition over those with constant returns and perfect competition.

3- The former provide an elegant account of intra- industry trade, while the latter, it is often argued,cannot,. This paper provides an account of intra- industry trade based squarely on comparative advantage.

4- The key is to introduce elements of Ricardian trade theory within the Heckscher- Ohlin framework. This is appropriate, as essential characteristics of intra- industry trade imply the technical differences matter. Increasing returns , in short, are not necessary for intra- industry trade.

5- Consumer preferences are defined as the subjective

( individual) tastes, as measured by utility, of various bundles of goods. They permit the consumer to rank these bundles of goods according to the levels of utility they give the consumer. Note that preferences are independent of income and prices.

6- The demand curve for a product shifts when consumer tastes change. An increase in the price of a product causes an increase in demand for substitute products and a decrease in demand for the product's complements. Consumer expectations cause people to demand either more or less of a good.

7- Types-

1- Trade in Homogeneous Goods.

2- Trade in Horizontally Differentiated Goods.

3- Trade in Vertically Differentiated Goods.

Although the theory and measurement of intra- industry trade initially focused on trade in goods, especially industrial products, it has also been observed that there is substantial intra- industry trade in the international trade of services.