A Traditional Trade Theory Based On Comparative Advantage

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Introduction A traditional trade theory based on comparative advantage(e.g. Ricardian and Heckscher-Ohlin model) has been criticised for its ineffectiveness in explaining the trade flow between industrialised countries and the exchange in differentiated products. This gives rise to a new trade theory which incorporates the scale of economies, product differentiation and imperfect competition into the discussion of trade pattern as a complement to the conventional theory(Krugman, 1980). While standard trade theory assumes constant return to scale to explain the international trade pattern and specialisation, scale economies plays an important role in determining trade flows in types of imperfect competition(Pugel, 2015). Economies of scale is especially useful in explaining the intraindustry trade and the development of a trading city. This essay will analyse the relationship between scale economies and trade in two parts. In the first part of this essay, I will assess the effectiveness of scale economies in explaining the trade and specialisation pattern(mainly focused on intraindustry trade), as well as economic clusters which leads to the development of cities. The second part of the essay will mainly focus on one empirical study from Krugman (1979) to further assess the relationship between economies of scale and the trade pattern across countries. 1.1 Scale economies in determining intraindustry trade Economies of scale suggests that the average cost of production
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