Trade with Imperfect Competition

The character of imperfect competition is often emphasized for describing decentralized allocations in the presence of increasing returns. Its competitive feature allows us to avoid complexity of strategic interactions among firms (like in oligopoly models). The modeling framework with monopolistic competition makes it possible to endogenize entry-exit processes and the range of products supplied in the market through these processes. In determining their prices in the short term, monopolistic competitors behave much like the differentiated products oligopolists. Taking the prices of other firms as given, each firm faces a downward-sloping demand curve – the downward sloping is held because of product differentiation. Each firm maximizes its profit at the point at which its marginal revenue equals marginal cost. In a short-run equilibrium, the price chosen by a firm may exceed the typical firm’s average cost at the prevailing output level. This situation will attract new entrants into the industry. As firms enter the monopolistically competitive market, a typical firm’s demand curve shifts. At a long-run equilibrium, a typical firm sets the profitmaximizing price equal to the average cost, making zero profit.

The purpose of this chapter is to introduce basic models of the new trade theory. Section 3.1studies a trade model with monopolistic competition by Krugman. The Krugman model addresses relations between trade and elements such as economies of scale, the possibility of product differentiation, and imperfect competition. The model is specially effective for providing some insights into the causes of trade between economies with similar factor endowments. The model is based on a monopolistic competitive model proposed by Dixit and Stiglitz. Section 3.2 introduces the Chamberlinian- Ricardian model proposed by Kikuchi. Rather than assuming crosscountry technical homogeneity like in the model in Sect. 3.1, the model is concerned with cross-country technical heterogeneity. There are two sectors: the monopolistically competitive sector and the competitive sector – the former produces a large variety of differentiated products and the latter produces a homogeneous good. The homogeneous good is produced under constant returns to scale. Section 3.3 analyzes the interplay between factor abundance and agglomeration forces, basing on a model of agglomeration by Epifani. The model synthesizes the Heckscher-Ohlin theory and the monopolistic competition. Section 3.4 tries to examine economic mechanism for the phenomenon that a large part of international trade is intraindustry in character. The section uses a simple model to demonstrate that although it is costly to export the product from one country to another, firms in different countries may engage in cross-hauling of an identical product, making positive profits. Section 3.5 introduces a model of extending the Heckscher-Ohlin international trade theory to include variable returns to scale. Section 3.6 analyzes the effects of transboundary pollution on trade and welfare in a general equilibrium.