Name – Shivani Mehta

Indian Institute of Logistics

Assignment 1
Implications Of New Trade Theory
New Trade Theory
The new trade theory of international trade refers to an accumulation of various economic models that
focuses mainly on returns of scale, first-mover advantage, and network effects on international trade and
globalization. For example, the new trade theory by Paul Krugman has got based on his ideas that
analyze trade patterns based on the location of trade activity, for which he received the Nobel Prize in
economics in 2008.

Network effects and economies of scale have the potential to be so potent that they could even defeat
the more well-known concept of comparative advantage. As a result, some industries might not notice
noticeable changes in opportunity costs between the two countries at a particular time. A country,
however, may profit from its specialization if it concentrates on a particular industry due to economies of
scale and other network advantages.

The new trade theory Is a contributing component in explaining the expansion of globalization. It implies
that less developed, underdeveloped nations may find it difficult to establish some industries as they
enjoy economies of scale like the industrialized world. It is mainly a result of the scale efficiencies
existing among mature enterprises and not of any inherent comparative advantage.

Prime Factors
Thus, the main factors of new trade theory are the following:

 Economies of Scale

Under this aspect, goods per unit cost gets reduced when they get produced in huge volumes. It gets
aided by IT technology, automobiles, and large-scale production machines. Domestic firms do not use it
because of low demand, but when the demand for goods from foreign countries gets highly high,
economies of scale reduce the cost of production per unit. Every country has a specific industry with
such capability and can lower the cost of production by increasing the variety of goods.

 First-Mover Advantage

It attributes to the fact that the earlier a firm gets into producing certain goods, the more economical
and strategic benefit it gets over the late entrants. It happens because early entrants’ low-cost structures
develop into giant firms like NOKIA.

 Network Effects

It states that their value increases with increased users of products. An example includes the internet.
Assumptions
Economist Paul Krugman based this theory on certain assumptions. The assumptions of the new trade
theory are the following:

 With specializations of firms, they increase their economies of scale.

Product differentiation and product specialization become essential in the growth of a firm.

Examples

Let us look at new trade theory examples to understand the topic better.

Example - 1

The first example would deal with the giant mobile phone manufacturer NOKIA. It started its mobile
manufacturing in Finland. It had its base in the electrical and electronic equipment manufacturing
company. NOKIA brand became the first-ever company to foray into manufacturing mobile and related
parts in the 1990s. Due to its strong financials, it implemented economies of scale in mobile phone
manufacturing. Finland’s government also supported its mobile manufacturing venture. Thus, for almost
15 years, it had a monopoly in mobile phone manufacturing. However, with time, people started using
NOKIA to a great extent, making it a valuable mobile company. Hence, government support, economies
of scale, network effects, and first-mover made it the undisputed leader of mobile phones for over a
decade.

Example - 2

TESLA is a popular brand in the electric vehicle segment. TESLA had been the early entrant or the first
mover into manufacturing electric vehicles (EVs) for the public on a large scale. With time, it transformed
from an American EV to a global EV manufacturer. TESLA gained a monopoly in the market by doing the
following:

Being the first mover into EV;

Getting subsidies from the American government;

Having economies of scale due to huge funding available; and

Rising value of its cars, creating network effects, led to monopolistic tendencies in the EV manufacturing
sector.
The Implications of New Trade Theory for Nations
 Nations may benefit from trade even when they do not differ in resource endowments or
technology
 A country may dominate in the export of a good simply because it was lucky enough to have one
or more firms among the first to produce that good
 Governments should consider strategic trade policies that nurture and protect firms and
industries where first mover advantages and economies of scale are important 5-45

The Implications of Trade Theory for Managers

1. Location implications – a firm should disperse its various productive activities to those countries
where they can be performed most efficiently  firms that do not, may be at a competitive disadvantage
2. First-mover implications – a first-mover advantage can help a firm dominate global trade in that
product

3. Policy implications – firms should work to encourage governmental policies that support free trade

Firms should lobby the government to adopt policies that have a favorable impact on each component of
the diamond

One can conclude from the new trade theory that the variety of products brought to the customers for
their use from the trade allows customers to benefit from it. It happens because a product monopoly
happens, and companies compete with each other using advertisements.

It implies that any gain arising out of intra-industry trade happens because of economies of scale in
manufacturing products of unique designs instead of the specialization of products related to a specific
category.