Model assumptions

assumptions practice

Assumptions of classical models

• perfect competition

• no trade frictions

• focus on trade between different countries

Assumptions of the ricardo model

• 2 sectors

  • E.g food (F) + manufacturing (M)

• 1 factor of production

  • immobile 

• Technology differs across sectors and countries

• Constant returns to labour 

  • no diminishing returns

• Perfect competition

• Constant returns to scale production

• Identical and homogenous tastes across two countries

Assumptions of the specific factors model

• 2 sectors

• 3 FoP

  • L: labour

  • K: capital

  • T: land

• mobile FoP

• Diminishing returns to scale & complementarity of factors in sector output

• w=P x MPLA

• Rent of land =PA x MPTA

• Marginal returns

Assumptions of the heckscher-ohlin-samuelson model

• 2 sectors (e.g. shoes (s), computers (c))

• 2 factors of production (e.g. Labour (L), capital (K))

• Factor endowments: cross-country differences in relative factor endowments (K/L ratios)

• Factor intensity: cross-sectoral difference in actor intensity of production of both goods

• Positive but diminishing returns

Assumptions of new trade theory

• imperfect competition 

• optimal firm behaviour, rather than countries

• increasing returns

• focus on trade between similar countries

• gains in

  • efficiency

  • variety

  • competitiveness

define terms of trade improvement

able to purchase more imports for each export

• relative price of exports rises

Assumptions of the Brander/Krugman ‘reciprocal dumping’ model

• Per country: one monopoly, one product

• Products being produced are “identical”

• Marginal cost constant

  • (without loss of generality)

• No trade frictions

• Cournot comp

  • No strategic interaction when making output decisions

Assumptions of Krugman (increasing returns) model

• Symmetric firms, diff varieties of good

• Supply side

  • Increasing returns to scale at the firm level (fixed costs)

  • (downward sloping AC curve)

• Monopolistic comp, free entry 

  • Until operation profits=0 (cannot cover fixed costs)

• Demand side

  • ‘Love of variety’ preferences (CES)

• No trade frictions

Base Krugman model only states:

[elasticity is a 1/(1- of markup)]

how can this model be expanded?

• larger markets can accommadate more firms

• more firms = higher elasticity = lower markup

• more firms = higher average costs

• consumers get more variety, and market power is shared between more firms

  • welfare gains

“new new” trade theory assumptions

• differentiated firms 

• exporting firms amount usually small, usually consist of large firms

• trade liberalisation increases productivity

  • inter-industry

    • shifts in comparative advantage

  • intra-industry

    • more productive firms self-select into trade market

  • identical

    • economies of scale

  • differentiated

    • innovation

Melitz model assumptions

• Monopolistic competition

• Each firm, indexed i, produces one differentiated product

• Demand for all products is symmetric

• Firms have fixed cost (F) to enter the market

  • So economics of scale + fixed entry cost (f)

  • Also fixed and marginal costs for expecting. All fixed costs are sunk

• Firms are heterogenous

  • Differ in marginal costs of production, ci 

    • random productivity draws ‘at birth’