Basic models of international trade II
This model is also attractive because increasing returns are internal to the firms, so the problem of multiple equilibria does not arise (as it did in the models of external economies reviewed in Chapter 2). Furthermore, as Matsuyama has pointed out, by assuming that firms are very small, we don’t have to worry about strategic interactions between firms that make any general treatment of oligopolies impossible. Although this type of model relies heavily on specific functional forms (e.g., CES utility), it remains appropriate to model global phenomena using the monopolistic competition model.2 In this chapter, we present the now standard Dixit-Stiglitz-Krugman trade model of monopolistic competition. Furthermore, we propose a convincing graphical exposition that emphasizes the firms’ entry-exit process, which will be used in later chapters. The following section presents the basic model. The nature of the trading equilibrium is considered in section 3.3. The effects of factor mobility are briefly reviewed in section 3.4, followed by concluding remarks in section 3.5.