6 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Ninth Edition
between industries and one factor that is specific to that industry. The advantage of this model over the
simple Ricardian model is that it highlights the distributional effects of trade, with some sectors of society
gaining and other sectors losing even though the net welfare effect of trade is a gain. These distributional
effects of trade highlight the commonly voiced oppositions to free trade, and this chapter examines three
reasons why protectionism is an inefficient method for dealing with the losses from trade. The chapter
concludes with an application of the Specific Factors model to international labor migration, focusing
again on the distributional effects of free trade in labor.
Chapter 5 introduces what is known as the classic Heckscher-Ohlin model of international trade. Using this
framework, you can work through the effects of trade on wages, prices, and output. Many important and
intuitive results are derived in this chapter including: the Rybczynski theorem, the Stolper-Samuelson
theorem, and the Factor Price Equalization theorem. Implications of the Heckscher-Ohlin model for the
pattern of trade among countries are discussed, as are the failures of empirical evidence to confirm the
predictions of the theory. The chapter also introduces questions of political economy in trade. One important
reason for this addition to the model is to consider the effects of trade on income distribution. This approach
shows that while nations generally gain from international trade, it is quite possible that specific groups within
these nations could be harmed by this trade. This discussion, and related questions about protectionism versus
globalization, becomes broader and even more interesting as you work through the models and different
assumptions of subsequent chapters.
Chapter 6 presents a general model of international trade, which admits the models of the previous
chapters as special cases. This “standard trade model” is depicted graphically by a general equilibrium
trade model as applied to a small open economy. Relative demand and relative supply curves are used to
analyze a variety of policy issues, such as the effects of economic growth, the transfer problem, and the
effects of trade tariffs and production subsidies. The Appendix to the chapter develops curve analysis.
While an extremely useful tool, the standard model of trade fails to account for some important aspects
of international trade. Specifically, while the factor-proportions Heckscher-Ohlin theories explain some
trade flows between countries, recent research in international economics has placed an increasing
emphasis on economies of scale in production and imperfect competition among firms.
Chapter 7 is the first of two chapters to reflect these developments in international trade theory. With external
economies of scale, average costs in an industry fall as industrial production rises (though not necessarily
the production of any one firm in that industry). As a result, when two countries trade, it makes sense to
concentrate production in one country as this will lead to lower costs than splitting production across two
countries. As with the trade models presented in previous chapters, countries with the lowest production
costs will be exporters, but in this case, the source of low costs is not driven by differences in technology
or factor endowments. Rather, a country with an established industry will be more competitive than one
in which the industry has to start from scratch. This is true even if the established country would not be
the lowest-cost producer if both countries started off at the same level of production. This suggests that a
country could be made better off by closing off from trade, though such cases are difficult to identify and
this form of protectionism may lead to unintended consequences such as retaliatory tariffs.
Chapter 8 examines how trade can be driven by internal economies of scale and monopolistic competition.
An internal economy of scale exists when a firm’s average costs decline as that firm increases its production.
Such a situation leads to a model of imperfect competition (there are a few large firms rather than many
small firms), and it can be used to explain the high degree of intra-industry trade in the world. The chapter
concludes with a discussion of foreign direct investment. The decision by a multinational to serve a
foreign market through a foreign affiliate or to break up its production chain is driven by a
proximity-concentration trade-off in which it must balance economies of scale (producing everything in
one place) with trade costs and differences in factor prices. This subject matter is important because it
shows how gains from trade may arise in ways that are not suggested by the standard models of
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