Ans. The contemporary theories of trade deviate from the assumptions of perfect competition and constant returns to scale made both in the classical and the neoclassical models. In the modern theories the market structure is either monopolistic or oligopolistic. In the former case a large number of producers produce goods that are not identical but differentiated in quality or design. In the latter case only a few producers serve the market with either identical products or differentiated products. The products which are just differentiated horizontally are similar in quality but different in design, like a red pen and a blue pen, white wine and red wine or wooden furniture and steel furniture. Vertical product differentiation involves quality differences as in small cars and large cars, lf b the products are horizontally differentiated they are produced by more or less the same technology. Vertical product differentiation would invariably mean that the technology varies with quality or type of the product.
The modem theories assume economy of scale in production. An
example of economy of scale is shown in the following Table 2.2.
Table 2.2: Economy
of Scale
|
Labour |
Units of Output |
|
3 |
1 |
|
5 |
2 |
|
6 |
3 |
|
7 |
4 |
|
8 |
5 |
|
9 |
6 |
|
10 |
7 |
One may easily check that the technology described above is
a departure from the constant returns to scale we have been using so far. For
example the output is doubled from 1 to 2 as labour is less than doubled from 3
to 5. Suppose that there are two similar goods, A and B being produced by the
above technology, The economy has 10 units of labour. The consumers will
consume the two goods in 1:l proportion. Therefore the labour force will have
to be equally divided in the production of the two goods and 2 units each of A
and B will be produced and consumed in the economy. Now suppose there is
another economy with the same technology to produce A and B having 10 units of
labour. Then it is quite easy to see that one economy produces only A and the
other produces only B and then trade with each other then the consumers in each
country will be able to consume 3.5 units each of A and B and be better off
than autarky. This is an example of trade taking place between two countries
having the same technology and factor endowments simply due to economy of
scale. But there is difference in the nature of trade. In the earlier models
the products were different and produced by different technologies and the
trade was between two industries, such as one country exporting cloth and
importing wheat. This kind of trade is called inter-industry trade. But in the
contemporary models trade is intra-industry, i.e., in the same industry located
in two different countries. It is like one country exporting white wine and
importing red wine - both goods requiring the same technology as in the above
example. It turns out that a very substantial part of world trade is
intra-industry in nature which shows the importance of modem theories in the
contemporary world.
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