82 lnternational Economics - Vol. 1 Part One TAc Tlreorr of IntenvttintLlTi,ult sector {the one using the country's scarce facior intensively;. The changes in prodr:c- tion have one set of effects on incomes in the short run. but another in the long run. Short-Run Effects of Opening Trade In the *$:*rt't ru* laborers. plots of land. and other inputs are tied to their curreirt lines of prodiiction. The denand for these t-actors, and therefore the incornes or returns they earn, depend on the sector in which they are empioyed. Sorre peopie rvill enjoy higirer demand tbr the factors thev have to offer, because their iactors are employed in the sector that is atteinpting to expand its production. With the open- nig to tree trade, the expanding industries in oLrr exarnple are u,heat in the tJnited States anil cloth in the re st of the world. in the Uniled States landlords in rvheat- grorving ateas can clrarge higher rents because thelr land is in strong derna*d. U.S. iurn1**k.rs in wheat-glowrng areas are likelv to get (temporarily) irigher wages. Foreign clothrvorkers cin also dernand and get higher wage rates. Foreign landlords in thJ areas raising cotton atld u,ool ibr cloth-making can also get higher re*ts' rlrLd'rntrii!. rlru rwllrrc vl fcrvrvr., t- th,c clcclir,ir,6 iutlu;tri'+t g.g. a!'31.11'.t'ot!.et'S' U.S. landlords in areas supplS'ing the cloth-nraking industry, fbreign rvheat-area laitd- lords and farnrhands- lose income through reduced clemand and therelbre reduced prices fbr fheir services. Fol the shorl run" tiierl. gains and losses divide by output secfor: All groups tied to rising sectors gain, and all groups tied to declining sectoi's lose. One lvould expect empiovers. landlolds. and workers in the declining sectors to uttite in protest. The Long-Run Factor-Price Response ln the i<,r*q r*-*n factors can move between sectors in respr'rnse to ditferences in returns. Sellers of the same factor r.viil eventually respond to the inconle gaps that have been openecl up in the short run, Sorne U.S. clothrl,orkers will fincl better-payingiobs iu the wlieat sector. r\s the supply of labol into the nheat sector increases. lvages ilt the rvheat sectol'decline. As the remaining supply af labor to the clolh sector shritrks, wages in the cioth sector increase. Sorne U.S. cotion- and wool-raisirig land will also get better rents by converting to lvheat-related producfion, bringing rents in rjilfbrent areas back in 1ine. Similarlv, foreign farmhands and landlords r,vill flnd the pay better in the cloth-relate<l sector. As the sr:pplies of the f'actors to the two sectors change in the iong run. wages and rents iri the cioth sector decrease, and wages aud rcnts in tlte lr,heat sector increase. The full process of the effects olopening trade on l'aclor prices in the long run is summarized in Figure 5.1. when the facto|s respond by rnoving to the better-paf ing scctors' will all n'ages arid rents be bicl back to their pretrade levels'l No. .

1. 82 lnternational Economics - Vol. 1
Part One TAc Tlreorr of IntenvttintLlTi,ult
sector {the one using the country's scarce facior intensively;.
The changes in prodr:c-
tion have one set of effects on incomes in the short run. but
another in the long run.
Short-Run Effects of Opening Trade
In the *$:*rt't ru* laborers. plots of land. and other inputs are
tied to their curreirt
lines of prodiiction. The denand for these t-actors, and therefore
the incornes or
returns they earn, depend on the sector in which they are
empioyed. Sorre peopie
rvill enjoy higirer demand tbr the factors thev have to offer,
because their iactors are
employed in the sector that is atteinpting to expand its
production. With the open-
nig to tree trade, the expanding industries in oLrr exarnple are
u,heat in the tJnited
States anil cloth in the re st of the world. in the Uniled States
landlords in rvheat-
grorving ateas can clrarge higher rents because thelr land is in
strong derna*d. U.S.
iurn1**k.rs in wheat-glowrng areas are likelv to get
(temporarily) irigher wages.
Foreign clothrvorkers cin also dernand and get higher wage
rates. Foreign landlords

2. in thJ areas raising cotton atld u,ool ibr cloth-making can also
get higher re*ts'
rlrLd'rntrii!. rlru rwllrrc vl fcrvrvr., t- th,c clcclir,ir,6
iutlu;tri'+t g.g. a!'31.11'.t'ot!.et'S'
U.S. landlords in areas supplS'ing the cloth-nraking industry,
fbreign rvheat-area laitd-
lords and farnrhands- lose income through reduced clemand and
therelbre reduced
prices fbr fheir services.
Fol the shorl run" tiierl. gains and losses divide by output
secfor: All groups tied
to rising sectors gain, and all groups tied to declining sectoi's
lose. One lvould expect
empiovers. landlolds. and workers in the declining sectors to
uttite in protest.
The Long-Run Factor-Price Response
ln the i<,r*q r*-*n factors can move between sectors in
respr'rnse to ditferences in
returns. Sellers of the same factor r.viil eventually respond to
the inconle gaps that have
been openecl up in the short run, Sorne U.S. clothrl,orkers will
fincl better-payingiobs
iu the wlieat sector. rs the supply of labol into the nheat sector
increases. lvages ilt
the rvheat sectol'decline. As the remaining supply af labor to
the clolh sector shritrks,
wages in the cioth sector increase. Sorne U.S. cotion- and wool-
raisirig land will also
get better rents by converting to lvheat-related producfion,
bringing rents in rjilfbrent
areas back in 1ine. Similarlv, foreign farmhands and landlords

3. r,vill flnd the pay better
in the cloth-relate<l sector. As the sr:pplies of the f'actors to the
two sectors change in
the iong run. wages and rents iri the cioth sector decrease, and
wages aud rcnts in tlte
lr,heat sector increase. The full process of the effects olopening
trade on l'aclor prices
in the long run is summarized in Figure 5.1.
when the facto|s respond by rnoving to the better-paf ing
scctors' will all n'ages arid
rents be bicl back to their pretrade levels'l No. tliey will not. In
the long run. wage rates
encl r:p lorver tbr att U.S. workers and higher for all frrreign
workers (each relative to
its leve1 with no trade). A1l land lents end up liigher in the
United Stales and lower in
-fhe.re-strf',the ruorid.{each relative to its level r'vith tto trade)'
What drives thrs crucial resuit is the imbalance in the changes
in factor supply and
demand. Wlieat grolving is more land-intensive and less labor-
intensive than cloth
making. Therefbre, the amounts o1'each factor beitrg hired in
the erpandillg sector
tvi1l not match the amounts being released in the other sector.
The imbaiances create
pressures f'or f-actol prices to adjust.
ii:i.:,ii;ii:--', 1:

4. l1or.,, Ft'ee l-rade
Ailects Ittcotr:e
Distribution
rn the L-ong
Rr:n: The
l1'hole Chain of
inl-luence
lnternational Economics, 1 5th Edition 83
Chapter 5 Iilrr.r (l,rrtts rtncl Illo Lo.re.r f-on
-Ir.r.Jt''
iAt this point^ fhe shor.t-run effects come into play. bi-rt the
ecr:noll)'colltinues to ll1ove torvard the longerlr"tn
etfects shorvn in the rest ofthis fisure.
i1 the ljniteci States. for example, exp{tnding wheat production
creates demand for
a lot of land and very f-ew workers, whereas cutting cloth
productiott releases a lot of
workefs and not so fiuch lancl.1 SrNnethirrg has to give.'fhe
onl'; /ay the etnploynlent
of labor nild land can acljusi to the available national supplies
is for tactor prices to
change. The prodgction shill toward land-intensive. labor-
sparing l4leat raises rents
and crrrs L/ages thrtntglrtni the Liniteci States in the long run.
The rise in rents alld lhe
fa11 in ruagei Lroth continr-te until producers cor:le up rvitll
ttrore land-saving and labor-
gsiltg ways of rnaking wheat aud cioth. Once they do, rents aurl
rvages stabilize-{:rrt

5. Li.S. renls stili eld up higher ancl ra,ages lower than betbre
trade opened up.
-[he
sane
kind olreasoning makes ttte opposite results hold for the iest of
tlie rvorld.
'L"ade. then. makes some people absoluteiy better oll and others
absolutely worse
ofl in each ol tire trading countries. The gainers ancl losers in
fhe sholt ruli are
This passace uses conr.renieni shorthand that is qrrantiiatiirely
riague: "'r lot cf " lartcl' "i'rety fet"'" vvotkets'
and sc on.:Ihese sliouicl give the riqhi rmpressions ir';iIh a n-
rinimurr o1'verbiaqe. Foi rrrote precision aboui
tlre irrplred inequallttes, see the nurneticai exam;rle in the i:ox
"A i:acicr-Ratio Pata<jox."
ln the Rest o{ the Worldln the United States
Wheat expensive,
cioth cheap
Wheat cheap,
cloth expensive
lnitial pricesr
Trade opens:
-

6. wheat--*->.
< al61[-
Pwheat uP,
P.1o,5 down
Produce more wheat.
Produce less cloth.
Pr"1"u1 down,
Pcto& uP
Produce less wheat.
Produce more cloth,
Prices respond
to trade.
Prociuction
responds to
prices.*
For each unit o{ wheat
sacri{iced, much land and few
workers laid off; extr"a cloth
demands many workers
and little land,
For each unit o{ cloth
sacrificed. many workers and
a small amount of land laid
of{; extra wheat demands
few workers and much land.
Crucial step-

7. National factor
markets
change.
National factor
prices respond.
Wage rates fall and rents i Wage rates rise and rents
rise {in both sectors). j iall (in both sectors}.
Product prices equalized between countries. Net gains {or both
countries but different ef{ects on different groups. Wilners:
U'S'
lando,,n;ners, foreign workers. Losers: U'5' workers, {orelgn
landowners,
Lonq-run results:
,: l"iTW
y*r S#?7. Part O:re
F1&*&€,s"*
Winnersaild
Losers; Sliart
Run versus
Long Rutl'
:-,tj'1.-.l,1..],i,,.].:,,'',.i
:':.'::l:t";tlt"lr''""..lt;".'1".-:;;::*::,*::;J; lea'ing zero net gai:r'
lnthe long run
n.*ino,,,rh" s1i*
T1l:t',1'.n'"lX::x..il",1ff#ij::T'flJ::f#lt;;:f:J'##;;;;r*v

8. botli coutrties get net
g.arns'^ r, .i. , - r G^+^r r , l
i;'*;# *;i;tt*niex of displaced bctors'
-- ^.1:.'dlfla
, somel'hat different frou those in the lonq'ryr1.'?'"*o
mlie adjus"yent can oicur
m
the long run. Figprg 52.,d;;;;- th* li*'eossiffiilj$Fi
*o io.*'' in the'short
and long runs'
-e$*Hs *F THr H..*'T*4r*RY '
THRtrE ls/lPtlcAl tu*s
::
'
, . nplications for factor incomes. rhese,
:1;,*nn-,1ril#f;*11?,1tytr^ffif'.H;o,[*p,*ious
secdon :
The'Stol Per-Samuelson
Theorem
".s*il+s**rc*;: t*gg' This'tireorem
state; tal" grv'en cenain conditions
and
,Four important conditions and

9. assumptions ""1'1'1^t:iifi":t','.-ii[;:ll,$-:1T}'Jl1J;1",.
tT'#i;j":#*:i1i;*uly''-:fi ili-3'iff ;;;1ffi :lq*1ii;ltil*ffi
Ix'"'""
ilH!ti*rl;:f"'m:::l;l':?'xl"lill'"'ii[1.':':'.'ffi:*;:]Ltlrln*l:H?1"J;"q"'.
are fixed. though rhis
can be.relaxed some|h1t €f":I!:#r[iin pr"a*ing a product double'
...i,fr'";' '.']1u.,
.onuun'. return5 to scale
(e.9., it all TaclUI5 u>cu ll l H' "*-
then output o{ the
producr qoubles)' 'i
.,a
i
':l
90 ,nternational Economics - Voi. i
Patt One Thi, Ihe,rrr .4 litfrinlrtiorr.rl li.i{L
What we ncw know ahlout the mixtures of
productive factors that make up the exports and
imports of leading nationi has been learned
largely because Wassily Leontief was puzzled
in the 1950s. Leontief. a Nobei prize winner in
economics. set off a generation of fruitful debate
by foliowing the soundest of scientific instincts:
testing whether the predictions cf a theory really

10. fit the facts.
Leontief decided to test the Heckscher-Ohlin
theory that coun'tries will export products whsse
production requires more of the country's abun-
dant factors and import products whose produc-
tion relies more on the cauntry's scarce factors.
He assumed that the U.5. economy at that time
u,'as c;pital-abundant (and labor-scarce) relative
to the rest o{ the world.
LEdNTIEF.S
'OI
TEST
Leontief computed the ratios of capital stocks
to numbers of wcrkers in the U.5. export and
import-competing industries in 1947. This com-
putation required figuring out not only hcw
much capital and labor were used diretly in each
of these several dozen industries but also how
much capital and labor were used in producing
the maierials purchased from other industries.
As the main pioneer in input*output analysis, he
had the acivantage of knowing just how to multi-
ply the input-output matr;x of the U.5. economy
by vectors o{ capital and labor inputs, export
vaiues, and import values to derive the desired
estimaies of capitalllabor ratios in exports and
import-competing production. 5o the test of
the H*0 thecry was set. lf the United States was
relatively capitai-abundant, then the U.S. export
bundle should enrbody a higlier capitailiabor
ratio {K,/1,), tfran the capital/lat}or ratio embod-
ied in the U.5. production that competed nrith

11. imports (K^lL*).
Leontief's results posed a paradox that puz-
zled hirn and others: ln 1947, the Uniteci States
was exporting relatively labor-intensive goods
to the rest of the world in exchange for rela-
tively capital-intensive importsl The key ratio
(K,/L,J||K_/L^) was only 0.77 when !-l-0 said it
shoutd be well above unity. Otiler studie3 con-
firmed the bothersome Leontief paradox for the
United States between World War ll and 'ig70.
BFOADER AND BETTTR TTSTS
The most fruitful response to the paradox was
to introduce other factors of production besides
just capital and labor. Perhaps, reasoned many
economists iincluding Leontief himself), we
should make ure of the fact that there are .dif-
ferent kinds of labor, different kinds of natural
resources, different kinds of capital, anci so forth.
Eroader.'calculations of factor content have paicl
off in extra insights into the basis for U.S. trade.
True, the United States was somewhat capital-
abundant, yet it failed to export more capital
services thah it imported. 8ut the post-Leontief
studies showed that the United States was aiso
abundant in farmland and highly skilled labor.
And the United States was indeed a net exporter
of products that use these factors intensively, as
H-O predicts.
lbr physical caprtal. highly skilled labor, and unskilled labor.
For niediurr-skillecl
labor. the international contrasts are not neariv so sliarp.
Countries have them in shares
that tencl to be in the nriddle of the abundance -scarcitv

12. spc.cffum. with C,-hina being
an interesting exception.
Figure 5.3 conlinns rvhat rve knolv about the distribrition of the
tvorld's arable
(farrnable) land an<i forestland. These types of land are
relatively concentrated
Gi.'
&l'
si,&r.''
F
E
*-l
Hi
F3,
Hi
R
g.
#
H
tc
&.r
F'
B
&
pi
$1,

13. $i
$,'
*,,i
4ti!.
ffi
f+r
$il
. ,,
Fr.
$i,
Part Or-re Ti:. fii..,,r., ll hfenlrirr:r:.rj Jir.:.,
in Figurr' 6' I low averilge cost is achieved at iu output size of
100.000 units. Anri horvlarge is the unit-cosr penalty' fbr
sr'alrer ourpur r.*lt, ir"li;;';.ffi;'L''.*ro** .or,penaltl'lor a scale
of 50.000 urtits. conrpaied witli lorvest aver;rse cost at
100.000units" is about 15 percent 1: 12-3 * 2allzal.The ansivers
to these questions are inrpor-tant ftrr the type olstructure that
arises on the seller sirle of the market.If scale econonies are
moclest or moderaie. then there is room in the indirstry fbr
alaige nuntber of flrnts. If, in acldition, pr"o,r.ti n.*
cilfferertiated. then ne ha'e a
'rildibnn of- i mperf'ect colt.lpetition cal I ecl,...,,,,,,.,,,, _,,, 1,,.
; ;,
strucrure iri which , r&;
;;;;,;#t;;;;,;':;,;;*;.'"iil*n'';,1,t:"::n":fi3,.Tj
producing and seJling varieties.of the basic ptorti*r fJecause
each firm,s proclirct issomeu,har criffere'nt. each firm rras
some co,riroi;;..;;;;;;;.;;;;;,':i,;r*., rbr irspt'oduct' -l-his
cttrltrasts with the perfectly cornpetitive narket structure Lrseci
in stan-darcl trade fheorlr wrth perlbct conrplrtitiol, each of the

14. inciListry s rnany snrall firnsproduces an identical cotrluodity-
lile proouct, ,or*r the market price 65 given, ancibelie'es rhaf it
has no direct contr.or or intir,.n.. o"-ri,i, market prce.If scale
econotnies ale subsrantial,or.er u rrrt.-rung. of output. then it is
likely tliat afblv tlrnts wili grow to be large in.ordei'to reap'ttie-
icir*e
"conornies.
I j.a ferv lan:e tirn-rsdominate the glohal inrltrtlr.l rrer*pno-
be..r"'..,.g.r.riohrtrdr buarc econ0nltis, then wehave an :;i:' . ' .
-fhe
large iirms'i,, un origoplrl;'l;; that the1, can conrror or inflr-r-
ence pdces'; ke,r'issLte in on ortgopoty i, irJ*ju.ilu-lf drgrg
large rir.rns cor,pere
'virh
eaclt other
il^'i:ij: lot cqmpete,-too aggressiveiy, rtren rr rs possibte for rhe
ftrns roealr econofitlc (or p,re) profit' prolit
-qreater than tire noi'nrut retur-n to inuerte,l capital.In a iater
section of this cltapter. we present in-rlepth anal;,sis of hos, r€
cau usemonopolistic competition to better unclerstand ttre
clririers and irnplicatio's of interna-rionai trade' we then take a
lock at the rore oi";;il;;;in inrernarionar rracre.
External Scale Economies
'fhe
second rype of scale economlbs is external to any individual
firm. I;xt*r,:l*i:**le ecg:3}*rxi*s are based on the ri.*
oiun'*nru=lncuro, wifhin a specific geo-graphic area' The
aver"age cost of the rypicat iirrr'pt"ir"i"g tlre procru6 in rhis
areadeclines as rhe output ol ti.,* indrrytn {all the local
fitrvithin rrre area is targer. rxt*r,,ui..o,,onries exprain ,n-

15. t};rL;tll,:ltJiilj'fr,il:]||:?ol'some products in specific
geographic.r.ur. wrruiu.",rr. sources of externar scaleeconomi es
l) T here are several-pois i tri I i ti es.
External ecotlonttles can arise if concenlration of an industryls
flnls in a ge0graphicarea arracts greater local supplies of
specializ.o ,*roi.*u ior the inclustry or iarger pooisof
specialized kinds of laboirequired b1.the il;r.),';;;" r*o*on lhal
filmrnakins trmsclusrer in Hotvrootl lancl irr Niunibai"
fornierrl.. Bo;;; il;. il;;.ilffi,;wood.)is that a deep pool of
r'vorkers sr<irreotirii,e-";;l{;",its orfirrnrnakrng.nd a mrlgeol
compatries provirling special services to facilitate fihnmaking
are available in iheselocati'ns' (You can also see tire self-
reinfgrcing ;$;;';;;.rernal scale economies-*ifyou lvant to break
into fjims and fihlmaking."or io offer-seruices to rii'r
companies,you knorv where you need to go. ) External
ecinonrjes .nn rrrn result as n.ru t norlt*ag.about prodtlct ancl
production-tecluology (or other useful business intor.rnatjon)
cliifusesquickly alnong flrrns in the area, through direct
coatacts unrong the f irms or as skilleilr'vorkers fia'sfbl from
firm to firm. K_nowledge ;rft;;; is rapid and perso'ner
arecontinuallv shifting among the high_tec}rnot..,g1r-
**flteirottrr"re.
semiconcluctor. and
lnternational Economics,
.l
5th Edition 1A7
Chapter 6 Sr:rle Econorrtiel, ln'$cfiect Oornperirilrr. rn,l lrtrtlc
::i:'
related fir-rns in Silicon Va1le.v. Ottrer examples of clustering
driven by exteriral scale

16. economies include banking and flnance in London and in New
York City; stylish clotlt-
ing. shoes, and accessories in ltaly; and watches in Srvitzerland.
The final seclion of this chapter examines how extertral scale
econotriies add to our
ability to analyze infernational trade'
i i:.i I it.iii' ; r!"i i3 i-j'$ T' iey gffi ee i"ll fl
According to our basic theories of comparative advantage. if a
cotntry trades in a
product, ii shsuicl either urostlv export the product (based on its
relatively loiv prOdttc-
tiot-r co.ts) or mostly import the product {as a result of its
relatively high production
costs). ve wr:uld see only int€r-t*l*{.*$try gr*d*" in rvhich a
coLnltry eKports some
products in tracle lbr irnports of other. qLrite diflerent products'
While much trade is inter-industr-v, especially in agricultural
products and other pri-
rnary procficts. there is also substantial l*i:"i ;r't:f iilif i
!.1;jl.lli iiiii--tivo-way trade in
rvhictr a corntry both exports and inrports the same or very
simiiar products (p:oduct
varieties that are such close substitutes that lhe-v are classified
rvithin the sanre indus-
trv). Figure 6.2 provides some exarnples of product categories
in rvhich the United
Siates engages iri intra-industfy tlacle. For exanple, tbr each of

17. pelfitntes and costnet-
ics. the amounr that the United States exports is close to the
amount that it imporls.
We cau quantib/ the relative importance of IIT in a cortntry's
trade in a productby
splitting the total irade {the sum of exports plus impolts) into
two conlpolients.
'Ihe
first cornponelt is i3*t cr,}{**. the difference belween expofts
and ilnports of that
prochict. Net trade is not intra-industry trade. Rather, net trade
shows the product'.s
importance in the country's inter-industry trarle. in which son"ie
products are (net)
exported. and other products are (net) irnportecl. In
measurentent rve often use the con-
veirtion that net trarle is a positive value if the country is net
exporter of the product.
and it is a negative value if the country is net importer of the
product. {Tlie "positive"
and "negative" are nct vaiue judgments. just ways clf
nreasuring.)
Intla-industrv trade is then the otirer corrponent of the country's
total trade irr tlte
proclgct, the an-iount of trade in rvhicli the country is both
exporting and importing in the
iarne proriuct category. l'here are tr.vo eqLtivalent vays to
treastlrc tlte atnount of a coutt-
triri intra-industry trade in a procluct. Fils:, it is equal to hvice

18. the value olthe smaller
of expotts or imports icapfrriilg the amount of exporting of the
prodrict fhat is nratched
b1' the sarr'le arlrount of importing ol the proclLict). Second
IIT is the part of total trade
in the product (expolts plus irlports) that is not net trade. Using
this latler approach,
IIT: (.Y + ktt - lx * 1t4i
rvbere X is the value ol export$ ol the. product and .44 is the
vah.ie of imports o1'the
prorluct. Fnrrherntore. rve often yant to compare the
irnportance of IIT across different
prr:ducts or ciiltbrent countries. Because the total amotlni of
trade diftbrs naftrraliy tbr
dilferent products or dillerent countries" re can meastlre the
relttlire inrportaltce 0f
intra-industrv trade. as a share ol total trade:
(I +.1,1) - d- ,1/lftT. ll Illlsnare= ---, .
lotal tradr
.-- r11l
ll- I - rx+ hktx + h{)
lnternational Economica . Vol, l
*S Part One Tl:r- Thearl of lntettuttronalT;rulc
rf*{JH€
For each product, intra'ildustry trade is the difference beiween
total.trade atld {the absolute value ofl net trade. The {IT Share

19. is intia-
industfytIad€asapelcent4geoftotaltrade,.]....
The,numbers in parentheses xe the Sdigit eode, Stanalard
lntemational,Trade Classification, Revision 3.
t
Source: Data & exports and imports fmm
UnitedNationS,,Cammodit!: Dilision, IlilCantrade DstabLte.
,The values of these vaiious measures are shown in Figue 6,.2.
For six of the seren
products (all butlargeaircraft),roverhalf of U.S.'total trade,inthe
product is IIf.
How large lslintra-indlstry tradein geneJal? It is more important
for trade. in manufac-
twed.products that it is for tade in agricultrnal products and
other primary products,
so let's focus on nonfcod, manufactured productsi Figure 6.3
shows the average share
of IIT.in the noafood.manufactures trade of'six indestriatized
countries. The estimates
are based on dividing the sector,inlo over 1,3'00'diftrent
prOducts"'To develap:the
estimatei..the uT shareis calc$lated far'eachofthese,products,
and then the weighted
average is.catculated,aoross all these'products (using the
counhy's total trade in the
produ;t as weights, so:that prodtrcts,with m-.ore total trade
receive more weight'in lhe
overall average).|The fine'level,ofproduct detail is necessary
so'that we have mean-

20. ingful, narrowly;defiued indus111-es W-e,t{y to-aVoid brasing
the measurement of IIT
tWe can show the formula for this weighted average of llT-
shares. To be clegr, let us add the subscript
I to the value for each products exports,and:'import5, to
emphasize that we are ar.'eraging over a
number of different PlQduct categories.
How lm portant ls'lntra.lndustry ifaAef
tn this formula, tho first katio) term is thle propcrtionate weight
lor each produci category,, and the
serond tetm is the calculated llT.share for each product
category' :
IntraJndustry Trade for the United States, Selected Products,
2009
] t',r,n,,.-r,]
lnternational Economics, 15th Edition I 1'09
Chapter 6 Sc,rL' Ecrr)l0r.rri(i' ltnlri'iiccr ( 'r']nJ)' iiiiiltl ({llrl J
jiitl'
Avelnge
Perceutage
Shates o{ intra-

21. lnilusfry Trade
irr the Countr:yi
Total Ti'ade
in Nonfood
Manutactured
Frodricts
Country
United 5tates
L dildud
t^^-^)dPdt I
Germany
France
United Kingdom
1989
55.3
54,3
l/.6
62.6
71 .3
69.0
2S05
58.3
63.2
41.2
67,'
13.9
11 -1

22. tr.
$rl
F.
il.
F'
sir..
g:;
*!'i
t".:
ir
! ::l
i,,
i,
i:i
.1.
:.'
a;
..
Iol e thflll hal l of overll l
For $ade il iloulbarl malufucturerl goocls (slTC 5 throtrghSi,
il1tla"in<lirstry tlade
is n'
trade for rtost intiustliaiized ,ount'it'' The e'riilrates ore based
on ot"er

23. l 'J00 tlillerent indn'idta]
ploduct
.*ijeo'i*'(fhe5-ttigittereloftlreSl.1'C.iter,isiorr2).
!t!ttilu!i,'tu! Itt,h hl'l trntnoli!r ll'tralwv '
$pwafrl rvhicir codd happen if we instead tsed broad p{O€luct
categofies i1
*arich
ve wollld be {rr:istakeniyi tind;ng {l'f rvhen a country expofiS
"ap1}les" and
irlpCIlts
':orrr,g.r;' tir ihe too-broad prodtlct calcgory *'as
"fruit")lt ,,-
As r,,,e can see ir'r tigur.L.3, tb.fir.e'of ihe six countrjes. IIT is
rrore
tllftn h1l1.Ltt-
total trade in nonfood ,ianut'acrures. ln additioo, the ilnportance
of II'l has tieet rising
in the past several decades f-or:lll these cortnffies. f he iuttto**
is especiallS'iarge
tbr
Japan. h} this aspecl of its itade, Japan it still rlifl'elent li'E:in
most ather indttstrialized
Cou11tl'ies"btititisn0w1es5c]il1-ererrtthanitLl5edt0be.
trve know fr.orll otirer studies that II't is mcre pfevaletli-where
tratie balriers

24. and
,transporr cosrs aie J;;;: ;;;;lti,, f,=iaontial-trade areas like the
Europeatr Unio''
i;t-i!t.6.3. the aveiage IIT:shar"es are particularly high lbr the
iitr*e E*ropean
cou*rries. Furrhermcre,ltr. i, nrore chalacieristic ol rhe {higlr-
lncome) ilrduslri-
aiir*J ."""tti*s. aod average tlT sk*tes tencl to be lorver tbr the
(lor'-itlcolne]
#;Jiopl;'.-i,.itr*. ror ittsTance, for, Clhtnai rade in-I992'-the
ave.rage ttl shlt1 l.,lr
its trarle in nonfoOd nratlufactures'was 20,9 pefcent' Even:this
ditference
is nar:row-
ing. tjror.igh. lbr the Oeoelopirrg cogntries fik* bhit'o that are
iniegratirrg
into the glottai
econony, Sy 2004. tfi* ot*ug; share ol ilT in llhina s tlade in
nolltbod
irtanufactured
prodilcts had riscn to 4t.i percent.
What Explains lnfa'lndustry Trade?
why elo ve'see so much intra-inclnstry trade'i'rhele are several
reasoils'
some mea-
,ur*,] ltt probably reflects trade tlrir,'err by comparative
advantage' For in-stance,' a

25. ,producr caregory *ui'Siili ne ,io" liroad- so ttrai it.include.'i
tlifferent products
that
ate Fr$duceci using dil.ferent productign
tuetilodS' Rrithin a cal*gol'y: ior ittstanee'
the united States nay exBol't ipecific products that are produced
using
skilled labor
;ni*,iuiuety nnd impoir oifi*t:tp*citic piodgcts that are
prnducecl
rtsing unskilled iab*t:
'ln ihe analysis of intra-industry tra(ie, a'.'ieil-defined
product category.con:ists of prclduct varie{ier
rrierveri as close sui:stitutesiy.ontrrn.ro a,rci prodL:ci-cl using
verylimiiar
f*ctor proporlions' ihe la,tter..is
;;;;;;;;or.n to tt.tn deiinitiorr oi an indi.istry stressed in lhe l-
leck*ciret-Chirn thecry
of coirrpalallve
acivantage, Altlrough we.;;;;i'p;;ti .t...n Jt these over 1,30t)
product caiegori€s
n-ie'eis lltis
deiinitisi r, il seems unlikelv ihat lhe c&iegorles generaliy ate
too btoac'

26. 110 lnternational Economics - Vol. 1
Part One T'lre 'fleln: of Inrrtirrtionrrl Ttrrl.
intensively. As another example. for some agricultural products.
III-'measurcd over a
Year may reflect seasonai comparative advantages. The Uniled
States expor"ts cherries
in July but irrports cherries in January.
Much intra-industry trade is driven by something other than
comparative aclvan-
tage. and the leading explanation focuses on the role of
glr*{**{t *jff*r**€*;l?i*r,--
consLlmers view the varieties of a product otTered by difierenl
lilns irr an industrv as
close but not perfect substitutes for each other. We can see the
roie of diiTerentiation
for the products sliown in Figure 6.2. Product difl'erentiation is
rampant in perfumes
and cosn':etics, r.vith strong brand na;nes. exotic packaging.
and rvide-ranging claims
for eff-ectiveness ancl high quality. For clothes wa-shing
machines. brancls tiom out-
side the tJnited States. including lVliele. Bosch, LG, Samsung,
and Flaier. contpete
ivith Whirl;:ool. Maytag, GE, and other U.S. brands. in
integrated circuits there is
ciifl'erentiation by specific circuit design as nell as by
functional specificarion, rvitir
U.S. firms like hitel. Texas Instrunenls. and Micron battling
with tbreign iirms like
'foshiba" Samsung" and Infineon. f-he range of automobile
models on oi'fur is obvi-
ouslv very large. {n iarge civilian aircraft the two firms are
Boeing_ and Airbgs. rvith

27. each offering models tliat compete rvith the other models on
design, lechnolerg1,. apg
otlter specifications. For cameras. consruners can choose fiom a
range of branc{ names
(including Canon. Sonv" Samsung, Kodak. and General
Electric) and ntodels that clif-
fer by fbatures and qnalit.v.
Procluct differentiation easil-v can be a basis for ffade. Sonre
buyers in a country
prefer varieties cf the product produced in a foreign country, so
thev $'ant to import
thc- product. The foreign varieties are iiot necessarill' cheaper
than the varieties pro-
duced by local ftrms. Rather, each loreign rrariet)'has dilleretrt
characteristics. and
these buvers find the fbreign rrarieties' charactedstics to be
desirable. Ar rhe sanre
time, sonte fbreign buyers prefer varieties produced b-v firms in
this coLtntr,v, and these
firms are able to expolt to the foreign country. Even if there are
no relative cost ciifl-er-
ences of the tvpe ernphasized by theories of comparative
advantage, there is interna-
tional trade. And, mucli of it can be intra-industry trade. rvith a
counry exporting and
importing diflbrent variants of the same basic product.
Yet. it is not only producf differentiation at r.r'ork in this
explanation. Taken to ihe
extleme, each of-ns rvould u,anl to bu-v the riniclue product
variant that exactly matches
our personal preference. This would be dift'erent fiom anyone
else's exact variant. so
the product variant would be completely customized to orr own
individrul taste. But we

28. know that tiris is not the case for the products shown in Figure
6.2. Each has a limiteci
nutnber of variants. The customizatiort is lirnited. What limits
the number of variants,
and the ailtount of customization'J The answer is sonie forr:r of
internal scaie econom;/.
so that there is a cost advarrtage to prodLrcing larger anounts
ola specific variani.
:.,i i: i.j ii Fli.l: t $ i? i { {_ i:} re ::} il'Ti ?' + 4:.} ix,e. ili i}'r
& & t} r
To understand rvhy ve see so rluch intra-industry trade" we
need a model of trade
driven by product dillbrentiation and scale econonies. ProdLlct
ilifibrentiation is a
deviation from the assurnption of a homo-eeneous product, otle
of the standard assump-
tions used in the analvsis of perfect competition" so we are
entering the realm of imper-
fuct contpetition. Our analysis is based on a rnild fbrrn of
imper'1bct competitian called