Apropos of Krugman's Nobel Prize, I thought there might be some interest in trade theory. Before we get to Krugman's contributions, we'll need to discuss some earlier insights.

Comparative Advantage

The idea of comparative advantage is one of the earliest and most important ideas about economic trade. David Ricardo explained it first in his 1817 work Principles of Political Economy and Taxation.

The simplest setup of the idea involves two countries (let's call them England and Portugal), two goods (let's call them corn and wine) and one factor of production (let's call it labor). We also need labor requirements for each good, which are assumed to differ across countries due, perhaps, to local conditions such as climate or soil characteristics.

First, let's say that in England it requires 2 hours of labor two produce one bushel of corn and 6 hours of labor to produce one barrel of wine. In Portugal it requires 4 hours of labor to produce one bushel of corn and 4 hours of labor to produce one barrel of wine.

With these labor requirements, England is said to have an absolute advantage in the production of corn, because it needs less labor to produce a bushel of corn than does Portugal. Likewise, Portugal is said to have an absolute advantage in the production of wine. One key insight here is that both countries can expand their consumption possibilities (compared to the case of no trade) by specializing in the good for which they have the absolute advantage and trading with the other company.

Now let's change the labor requirements slightly. In England it still requires 2 hours of labor to produce one bushel of corn and 6 hours of labor to produce one barrel of wine. In Portugal, however, it now takes 4 hours of labor to produce one bushel of corn and 8 hours of labor to produce one barrel of wine.

Now England has an absolute advantage in both goods. Portugal is said to have a comparative advantage in wine. To see why, consider the real prices of wine in both countries if there is no trade. In Engalnd, wine takes 3 times as much labor to produce as corn, so the real price of wine is 3 units of corn. In Portugal, wine takes 2 times as much labor to produce as corn, so the real price of wine is 2 units of corn.

Even though England has an absolute advantage in both goods, both countries can still gain by specializing in the good for which they have a comparative advantage and trading. (England has a comparative advantage in corn by the logic used above).

A simple setup like this would predict what goods a country would specialize in. It would also predict that a country exports some goods and imports others, but does not export and import the same goods. It also makes predictions about how prices change when a country is opened to trade.

The examples I talked about here only consider two goods, but see Dornbusch, Fischer and Samuelson (1977) for an elegant treatment of many goods. These types of models are usually limited to a single factor of production (or industries where other resources are 'fixed' over some period of time).

Could you please elaborate on Krugman's New Trade Theory that includes Economies of Scale?

Is this article pretty much what I am asking for? Increasing Returns and Economic Geography by Paul Krugman (1991)

And what do you personally think of the theory?

P.S I know the H-O theory on trade already.

13, I plan to get around to it. In the meantime, this is probably the best overview of Krugman's contribution to trade theory: Market Structure and Foreign Trade: Increasing Returns, Imperfect Competition, and the International Economy

TY,TY and take your time.

econophile,
can you recommend any intro books to int'l trade theory?

I have two on my shelf here:

International Economics: Theory and Policy by Paul Krugman and Maurice Obstfeld

The first half of the book is about trade theory and policy, the second half is about international macro (e.g. exchange rates). I have the fifth edition, which probably isn't substantially different from the current edition. When buying textbooks (especially undergraduate ones), you can save a lot by buying previous or international editions.

International Trade: Theory and Evidence by James Markusen et al. This one focuses entirely on trade, but is considerably dryer. It's also a bit more detailed.

Thanks, I'll probably have to look around a little to find a decently priced one.