Lecture 3
September 20, 2022 11:03 AM
Title: What is the role of firms in trade?
• It is crucial to look at individual firms to explain/understand trade
• Empirical evidence shows that:
○ Bernard et al. (2004): Exporters are not a random sample of existing firms.
YI it important to They are more productive, larger, are more capital intensive and pay
consider firm's
heterogeneity? better wages.
○ High concentration: most trade is in the hands of a few superstar
companies.
○ Most trade is actually intraindustry, not interindustry as modelled by Old
trade theories.
• New-new trade theory: firms heterogeneity matter
HD new (and new-new) • Imperfect competition is accounted for (building on the Dixit-Stiglitz model of
trade theory differ product variety).
from old trade
theories? • Firms are important because the differences among them (i.e.: productivity)
explains why some engage in trade and some do not.
YD Ricardian TT not • Ricardian trade theory does not look at firms because he assumes constant returns to
consider the firm- scale:
level? • According to constant returns to scale, if a firm produces 1 or 1000 cars there
W limitation of this are not differences in productivity
TT is a consequence ○ The only differences Ricardo account for sectors/economies.
of this? • Ricardo does not explain intra-industry trade.
HI the intensive • Empirical research shows that the 4 largest firms already accounted for the lion's share
margin of trade? of exports (~95%).
Y did Krugman come up • Krugman realized in 1978 that data does not show specialization as in Ricardo but
with a new trade intra-industry trade illustrates trade in varieties.
theory? (empirical
puzzle)
• Differences between Old and new trade theory:
WR the differences Ricardo/HO Krugman (1978)
between old and new
TTs? Perfect competition (identical Monopolistic competition: trade in
(type of competition, products). varieties.
motivation to trade,
type of trade) Comparative advantage in one good Increasing returns to scale (decreasing
(due to productivity/technology or AC) due to production concentration.
factor endowment).
Interindustry trade (never import Intraindustry trade (love of variety
what you export) allows for imports and exports in same
industry)
WI monopolistic • Dixit-Stiglitz (DS) came up with the monopolistic competition
competition?
• Demand: consumers like to demand different varieties, Krugman builds on the
Dixit-Stiglitz (DS) monopolistic competition model to explain intra industry trade
○ Demand is shown by a utility function (which is optimized by consumers)
○
YD consumers demand
different varieties?
○ It predicts that if there is a variety in the market, it will be consumed
because it yields additional utility.
FDI Page 23
, ○ It predicts that if there is a variety in the market, it will be consumed
because it yields additional utility.
○ See slide 12 for a numerical example.
○ The more varieties, the more welfare (gains from trade) due to love of
variety.
WD firms produce a • Supply: only one firm per variety, as the larger the output, the lower the average
single variety? cost (due to decreasing average costs)
YI a single variety ○ If firms enter the market, otherwise
produced by a unique
firm? they exit.
▪ Finally; one firm captures the market for this variety: one firm per
variety…
HR cost functions
assumed to be across ○ Assumes identical cost function of across ALL firms
firms?
Graph the
monopolistic
competition scenario •
(price*quantity)
• This DS theory tries to solve the Old trade theory's misfit of intraindustry trade.
WD the new TT assume • New trade theory: imperfect competition. All firms identical and all export
about firm's ○ However, data does not support that:
participation in
exports? (based on ▪ all firms are not identical and all do not export
identical cost □ Exporters have higher wages, productivity, income (salaries),
function) more capital intensive and higher-skilled workers.
D this check out in ▪ Extensive margin: Most exporters trade in a single product instead
empirical data? (in # of products, not in value)
(intensive & ▪ Intensive margin: the lion's share of value exported is in the hands
extensive margin)
of a single few firms, who mostly export many varieties to many
countries (and are the largest employers).
Y did Melitz come up • New new trade theory tries to explain why some do and some do not (i.e.:
with a new-new TT?
Melitz model building upon the Krugman model)
WD the Melitz model • Melitz (2003) model: aims to explain why some firms export and some don't.
want to explain?
• Consumers love variety (due to higher utility)
HD Melitz's cost • Cost side varies from that to Krugman by introducing firm homogeneity in
function compare to productivity
Krugman's?
○
WI assumed about
productivity? ▪ : productivity
○ Variable (and thus Marginal) costs differ per firm
○ Firm differences are impossible if:
▪ Goods are homogeneous
▪ Perfect competition
YD firms want to ○ Biggest firms make the most profits (CR ratios)
expand their market
(and output)?
Graph the profits
made by firms with 3
different prices
(2 graphs:
price*quantity +
FDI Page 24
September 20, 2022 11:03 AM
Title: What is the role of firms in trade?
• It is crucial to look at individual firms to explain/understand trade
• Empirical evidence shows that:
○ Bernard et al. (2004): Exporters are not a random sample of existing firms.
YI it important to They are more productive, larger, are more capital intensive and pay
consider firm's
heterogeneity? better wages.
○ High concentration: most trade is in the hands of a few superstar
companies.
○ Most trade is actually intraindustry, not interindustry as modelled by Old
trade theories.
• New-new trade theory: firms heterogeneity matter
HD new (and new-new) • Imperfect competition is accounted for (building on the Dixit-Stiglitz model of
trade theory differ product variety).
from old trade
theories? • Firms are important because the differences among them (i.e.: productivity)
explains why some engage in trade and some do not.
YD Ricardian TT not • Ricardian trade theory does not look at firms because he assumes constant returns to
consider the firm- scale:
level? • According to constant returns to scale, if a firm produces 1 or 1000 cars there
W limitation of this are not differences in productivity
TT is a consequence ○ The only differences Ricardo account for sectors/economies.
of this? • Ricardo does not explain intra-industry trade.
HI the intensive • Empirical research shows that the 4 largest firms already accounted for the lion's share
margin of trade? of exports (~95%).
Y did Krugman come up • Krugman realized in 1978 that data does not show specialization as in Ricardo but
with a new trade intra-industry trade illustrates trade in varieties.
theory? (empirical
puzzle)
• Differences between Old and new trade theory:
WR the differences Ricardo/HO Krugman (1978)
between old and new
TTs? Perfect competition (identical Monopolistic competition: trade in
(type of competition, products). varieties.
motivation to trade,
type of trade) Comparative advantage in one good Increasing returns to scale (decreasing
(due to productivity/technology or AC) due to production concentration.
factor endowment).
Interindustry trade (never import Intraindustry trade (love of variety
what you export) allows for imports and exports in same
industry)
WI monopolistic • Dixit-Stiglitz (DS) came up with the monopolistic competition
competition?
• Demand: consumers like to demand different varieties, Krugman builds on the
Dixit-Stiglitz (DS) monopolistic competition model to explain intra industry trade
○ Demand is shown by a utility function (which is optimized by consumers)
○
YD consumers demand
different varieties?
○ It predicts that if there is a variety in the market, it will be consumed
because it yields additional utility.
FDI Page 23
, ○ It predicts that if there is a variety in the market, it will be consumed
because it yields additional utility.
○ See slide 12 for a numerical example.
○ The more varieties, the more welfare (gains from trade) due to love of
variety.
WD firms produce a • Supply: only one firm per variety, as the larger the output, the lower the average
single variety? cost (due to decreasing average costs)
YI a single variety ○ If firms enter the market, otherwise
produced by a unique
firm? they exit.
▪ Finally; one firm captures the market for this variety: one firm per
variety…
HR cost functions
assumed to be across ○ Assumes identical cost function of across ALL firms
firms?
Graph the
monopolistic
competition scenario •
(price*quantity)
• This DS theory tries to solve the Old trade theory's misfit of intraindustry trade.
WD the new TT assume • New trade theory: imperfect competition. All firms identical and all export
about firm's ○ However, data does not support that:
participation in
exports? (based on ▪ all firms are not identical and all do not export
identical cost □ Exporters have higher wages, productivity, income (salaries),
function) more capital intensive and higher-skilled workers.
D this check out in ▪ Extensive margin: Most exporters trade in a single product instead
empirical data? (in # of products, not in value)
(intensive & ▪ Intensive margin: the lion's share of value exported is in the hands
extensive margin)
of a single few firms, who mostly export many varieties to many
countries (and are the largest employers).
Y did Melitz come up • New new trade theory tries to explain why some do and some do not (i.e.:
with a new-new TT?
Melitz model building upon the Krugman model)
WD the Melitz model • Melitz (2003) model: aims to explain why some firms export and some don't.
want to explain?
• Consumers love variety (due to higher utility)
HD Melitz's cost • Cost side varies from that to Krugman by introducing firm homogeneity in
function compare to productivity
Krugman's?
○
WI assumed about
productivity? ▪ : productivity
○ Variable (and thus Marginal) costs differ per firm
○ Firm differences are impossible if:
▪ Goods are homogeneous
▪ Perfect competition
YD firms want to ○ Biggest firms make the most profits (CR ratios)
expand their market
(and output)?
Graph the profits
made by firms with 3
different prices
(2 graphs:
price*quantity +
FDI Page 24
