Increasing returns

Job I; I .-)f bnternationai

Economics

9 (1979) 469-479.

0 North-Hollan,l

Publishing

Company

INCREASING

RETURK§, MONOPOLISTIC COMPETITION, Ah D INTEIRN.QTIOI\;A L TRADE

Received November

1978, xvisr.d vxsion

rscelved F‘ebruary 1979 trade. scale gains factor

This paper develops a simple, general equilibrium model of nonc0mparatii.e advantage Trade is driven byeconomies of scale, which are internal to firms. Because of the economies, markets are imperfectly competitive. Nonetheless, one can show that trade, and from trade, wi!l occur. even between countries with identical tastes. technology, and endowments.

I.

Introduction
Et

has been widely recognized that economies of scale provide an alternative tn differences in technology or factor endowmentsas a.n explanation of internatiomd specialization and trade. The role of ‘economies of large scale production’ is a major subtheme in the Work of Ohlin (1933); while some authors, especially Balassa (1967) and Kravis (19711, have argued that scale ecolnomies pl:~y a crucial role in explaining the postwar growth in trade among :he industrial countries. Nonetheless. increasing returns as a cause oftrade his rec.:eived relatively little attention from formal trade theory. The main reason for this neglect seems to be that it has appeared difficult to deal with the impiicationr of increasing returns for market structure. This paper develops a simple formal model in which trade is caused bq economies ol’ scale instead of differences in factor endowments or technology. The approach differs fromthat of most other formal treatments of trade under increasing returns, which assume that scale economies are external to f::rms, so tha:: markets remain perfectly competitive.’ Instead, scale economies are here assumed to be internal to firms. with the market structure that emerges being one of Chamberlinian monopolistic competition.” The formal
‘P utho:? v.ho allow for incra;ising returns Intrade bj, assuming that sc;~Ic ccontjrnic\ XIX t,xteI nal tr) firnl include Chacoliades (1970). Melvin t1969). and Kemp (1963). and N&Iii (196)). ‘1. Charnberiinian approach to international trade is suggestccl by Gra> (1973). Negishi t 19721 develops a full general-equilibrium model of scale economies. monopolistic.: competition. ;llxl llrade which is ,;imilar in spirit to this paper. though farmore complex. SGIIC ccontmies ant! product dinerentiation are also sugpsstcd as ca~~~cs of trade by Barker I I9771 anti Grubel (19X)).

treatment of monopolist.ic compeiition is borrowed with slight modifications from recent work by Dixit am! Stiglitz (1977). A Chamberlinian formulation of the problem turns out to have several advantages. First, it yields a very simple model; the analysis ofincreasing returns and trade is hardly more complicated than the two-good Ricardian model. Secondly, the model is free from the multiple equilibria which are the rule when scale economies are external to firms, and which can d.etract from the main point. Finally, the model’s picture of trade in a large number of differentiated products fits in well with the empirical literature on ‘intra-industry’trade [e.g. Grubel and Lloyd (1975)]. The paper is organized as follows. Section 2 develops the basic modified Dixit Stiglitz model of monopolistic competition for a closed economy. Section 3 then examines the elects of opening trade as well as the essentially equivaler‘ Gets of population growth and factor mobility. Finally, section 4 summarrzes the results and suggests some conclusions.

2.Monopolistic competition in a closed economy This section develops the basic model of monopolistic competition with which I will work in the next sections. The model is 3 simplified version of the model developed by Dixit and Stiglitz. Instead of trying to develop a general model, this paper will assume particular forms for utility and cost functions. The functional forms chosen give the model a...