Questions and Answers

Q1) What is meant by economies of scale? How can they be the

basis for international trade? What is meant by the term “New
International Economies of Scale”?
A1) Economies of scale are cost reductions that occur when
companies increase their production. They can be the basis of
international trade when production at a larger scale with more
output can be achieved by savings or cost reductions. The new
international economies of scale mean an increase in the
output at a lower cost or larger production at low cost.

Q2) What is meant by product differentiation? Why does this

result in imperfect competition? How can international trade
be based on product differentiation?
A2) Product differentiation is the process of determining a
product or service from others, to make it more attractive to a
certain target market. There are many sellers but they are
selling dissimilar goods and if a seller is selling a non identical
goods in the market, then he can raise the price and earn
profits. This results in imperfect competition. International
trade can be based on product differentiation by ‘Differentiated
Products’. Similar products produced by different
manufacturers in the same industry or general trade groups’
example: Toyota and Ford are differentiated products.

Q3) How can intra-industry be measured? What are the

shortcomings of such a measure?
A3) Intra-industry trade is the international trade in
differentiated products. It means trade within industries. Intra-
industry trade can be measured by the Grubel-Llyod Index, the
Balassa Index, the Aquino Index, the Bergstrand Index and
Glesjer Index. It is difficult to measure intra-industry trade
statistically because regarding products or industries as “the
same” is partly a matter of definition and classification.

Q4) What do we mean by monopolistic competition? Why do

we use this model to examine intra-industry trade?
A4) Monopolistic competition is a type of imperfect
competition such that many producers sell products that are
differentiated from one another and hence are not perfect
substitutes. This model is useful in explaining that trade
between countries that occurs within an industry rather than
across industries. This model demonstrates not only that intra-
industry trade may arise but also national welfare can be
improved as a result of international trade.
Q5) Why is it that the greater the number of firms is in a
monopolistic competitive industry the lower the price is, but
the higher the average cost of each firm is for a given level of
output?
A5) A monopolistically competitive firm is not productively
efficient because it does not produce at the minimum of its
average cost curve. A monopolistic competitive firm is not
allocatively efficient because it does not produce where P=MC,
but instead where P>MC. Thus, a monopolistic competitive firm
will tend to produce a lower quantity at a higher cost and to
charge a higher price than a perfectly competitive firm.

Q6) How do different environmental standards affect industry

and international trade?
A6) Environmental standards affect industry location and
international trade as they refer to the levels of air, water, and
other kinds of pollution that affect the levels of production.
Traded products may have high pollution contents and their
consumption causes increases in pollution and environmental
degradation. The trade in pesticides, fertilizers and chemicals
for example can lead to environmental deterioration in the
importing country.
Q7) How can international trade take place according to the
technological gap model? What criticisms are leveled against
this model? What does the product cycle model postulate?
What are the various stages in a product lifecycle?
A7) If the countries have similar factor proportions and tastes,
yet continuous process of inventions and innovations can give
rise to trade. When a firm develops a new product, its first test
is in the home market. This model has certain shortcomings; it
does not explain the technological gap or imitation gap in a
precise manner and it fails to explain why the technological
gaps arise and how they get eliminated over time. Product cycle
model explains that a product is initially produced and exported
by the innovation country but finally it ends up as an importing
country of the same product or same differentiation variety of
that product. There are four stages:
1) Stage 1:
The high income and labour saving products are introduced by
the producers of advanced countries like the U.S.A. as they are
well equipped to manufacture them. Initially the products are
introduced in the domestic market. After they gain acceptance
in the home market, these are exported to the countries having
similar tastes and levels of income. The innovating producers
enjoy virtual monopoly in both the domestic and foreign
markets for some time.

2) Stage 2:
In this stage, the foreign markets of the new products become
so large that the foreign producers start manufacturing them or
their close substitutes. As a result, the shares of the
manufacturers of innovating country in the world markets start
declining but they still supply considerably large quantities of
the product to the world market.

3) Stage 3:
The foreign manufacturers enjoy greater competitive
advantage over the manufacturer of the countries like United
States. Firstly, they enjoy the advantage of lower labour cost.
Secondly, they start enjoying the advantages of economies of
scale, which were being initially reaped only by the advanced
countries.

4) Stage 4:
Finally, the foreign producers reach out the markets of the
originally innovating countries despite transport costs and
tariffs imposed by the advanced countries and the innovating
countries become the net importers of the product. When this
situation develops, the country like the United States has to
produce new varieties of products which are consumed by
relatively well-off sections of consumers both at home and
abroad.