Chapter 5
Beyond Comparative Advantage
◼ Outline
Introduction: More Reasons to Trade
Intraindustry Trade
Characteristics of Intraindustry Trade
The Gains from Intraindustry Trade
Case Study: United States and Canada Trade
Trade and Geography
Geography, Transportation Costs, and Internal Economies of Scale
Case Study: The Shifting Geography of Mexico’s Manufacturing
External Economies of Scale
Trade and External Economies
Industrial Policy
Industrial Policy and Market Failure
Industrial Policy Tools
Problems with Industrial Policies
Case Study: Do WTO Rules Against Industrial Policies Hurt Developing Countries?
◼ What Students Should Know after Reading Chapter 5
One of the main objectives of Chapter 5 is to show that a large share of international trade is intraindustry
trade and to describe why this trade occurs. Intraindustry trade is not based on comparative advantage
28 Gerber • International Economics, Sixth Edition
Understanding the source of economies of scale (internal or external) and how that affects firm behavior is
also emphasized. Internal economies of scale may lower costs for existing firms and domestic consumers,
External economies of scale may come from regional agglomerations of firms. The decrease in costs
from an agglomeration may be caused by: (1) knowledge spillovers that help keep all firms abreast of the
New to the sixth edition is the incorporation of the of the model of monopolistic competition directly into
the text. In previous editions, this material was in an appendix to the chapter. As in the previous editions,
this edition keeps the discussion of scale economies and their impacts on the geography of production. The
The chapter bridges from external economies to industrial policy by explaining how small differences in
initial conditions can lead to large differences in outcomes because of scale economies. The example
focuses on U.S. agglomerations for aircraft production. European nations used subsidies and other
interventions to help Airbus become competitive against the U.S. cost advantages.
Chapter 5 addresses both the justifications for industrial policy (market failures) and also the challenges
facing governments when they try to intervene in any way that might possibly improve on market
allocations. While Chapter 5 tries to convey a sense of the range of industrial policies, its real goal is to
Chapter 5 Beyond Comparative Advantage 29
◼ Assignment Ideas
1. Ask students to analyze bilateral trade between two nations that have similar factor endowments.
Which items seem to be intraindustry trade? Which items seem to be interindustry trade? In percentage
terms, how much of the top-ten exports/imports are intraindustry trade? Has any political or media
attention been paid to this bilateral trade pattern, and if so, in what areas? (Assuming different
students focus on U.S. bilateral trade with different nations there may be some variation in answers
that could support the general idea that interindustry trade is more controversial because it necessarily
creates winners and losers.)
2. Have students choose an industrial policy and analyze it according to the criteria given in Chapter 5.
Begin with a description of the policy and then focus on whether the policy is justified. In particular,
for what market failure is the policy designed to compensate? Does the description of the policy
address this issue? Are there justifications for this particular industry and not for others? Finally, what
are the reciprocal obligations of the industry? Is it required to invest its own resources? Are limits
placed on its scope of action so that it cannot simply accept any assistance without meeting some
criteria for using the assistance?
3. Given the case study on commercial aircraft, students could seek information on the latest
developments in the trade disputes.
◼ Answers to End-of–Chapter Questions
1. What is intraindustry trade and how does it differ from interindustry trade? Are the gains from trade
similar?
Answer: Intraindustry is international trade of products made within the same or similar industries,
for example, car-for-car, beer-for-beer, etc. Differentiated products, which are
2. Comparing U.S. trade with Germany and Brazil, is trade with Germany more likely to be based on
comparative advantage or economies of scale? Why?
3. What are the differences between external and internal economies of scale with respect to (i) the size
of firms, (ii) market structure, and (iii) gains from trade?
Answers:
i. An external economy of scale exists when the fall in the average costs of the industry lowers the
average costs of the typical firm. With external economies, the size or scale effects are located
in the industry, and NOT THE FIRM. Thus, even though the size of each firm in the industry
Chapter 5 Beyond Comparative Advantage 31
4. What are the three key incentives for firms in a particular industry to cluster together in geographical
region?
Answer: These are: (1) large pool of skilled labor, which reduces the search costs and encourages
5. How might trade hurt a country if it imports goods that are produced under conditions of external
economies of scale?
Answer: Trade may stifle the development of new industries that could be more efficient than the
6. When the United States signed a free trade agreement with Canada (1989), no one in the
United States thought twice. When the agreement with Mexico was signed (1994), there was
significant opposition. Use the concepts of interindustry and intraindustry trade to explain the
differences in opposition to the two trade agreements.
Answer: Canadian productivity, technology, and factor endowments are more or less comparable
with those of the United States. Consequently, trade between the United States and
7. What are the theoretical justifications for targeting the development of specific industries?
Answer: The primary justification is to counteract a market failure. Although market failures come
in all shapes and sizes, all imply that markets do not result in the optimal allocation of
8. What are some of the common problems in implementing industrial policies?
Answer: They are: (1) the difficulty of obtaining information necessary to measure the extent of
9. Figure 5.3 in the text illustrates the case of an industry that generates external social benefits with its
production. Draw a supply and demand graph for an industry that creates external costs with its
production. Compare and contrast the market determined price and output level with the socially
optimal price and output levels.
Answer: In a negative externality the social returns are less than private returns, so a free