International Trade - Theory and Policy, 2010a

price. Canadians may demand more beer, the Dutch more wooden shoes, and the Japanese more fish than
Americans would, even if they all faced the same prices. There is no formal trade model with demand
differences, although the monopolistic competition model in Chapter 6 "Economies of Scale and International
Trade" does include a demand for variety that can be based on differences in tastes between consumers.
Reason for Trade #4: Existence of Economies of Scale in Production
The existence of economies of scale in production is sufficient to generate advantageous trade between
two countries. Economies of scale refer to a production process in which production costs fall as the scale
of production rises. This feature of production is also known as “increasing returns to scale.” Two models
of trade incorporating economies of scale are presented in Chapter 6 "Economies of Scale and International
Trade".
Reason for Trade #5: Existence of Government Policies
Government tax and subsidy programs alter the prices charged for goods and services. These changes can
be sufficient to generate advantages in production of certain products. In these circumstances,
advantageous trade may arise solely due to differences in government policies across countries. Chapter 8
"Domestic Policies and International Trade", Section 8.3 "Production Subsidies as a Reason for Trade" andChapter
8 "Domestic Policies and International Trade", Section 8.6 "Consumption Taxes as a Reason for Trade" provide
several examples in which domestic tax or subsidy policies can induce international trade.
Summary
There are very few models of trade that include all five reasons for trade simultaneously. The reason is
that such a model is too complicated to work with. Economists simplify the world by choosing a model
that generally contains just one reason. This does not mean that economists believe that one reason, or
one model, is sufficient to explain all outcomes. Instead, one must try to understand the world by looking
at what a collection of different models tells us about the same phenomenon.
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