Speed read: Modelling Trade in a World of Plenty

In a remarkably succinct, ten-page article published in 1979, Paul Krugman proposed a new trade model that changed the way economists view the international exchange of goods. At the heart of the model lay two concepts that reflected the general twentieth century trend towards having more: the increased production of goods, leading to economies of scale, and increased diversity of products, leading to greater choice for consumers. Krugman’s model better reflected the new pattern of international trade that had developed in a world where less certainly wasn’t more.

His model sought to explain the situation in which countries that are similar benefit by producing and trading in similar goods. Thus, cars are manufactured in France, Germany and Italy, with each country benefiting from the economies of scale delivered by mass production, and the citizens of each country benefiting from the increased choice that arises from having a global motor industry. Previous trade models had emphasized the importance of the differences between countries, with international trade being based on the production of different materials in each country to fulfil unmet needs in others. Krugman’s development of a rigorous framework for describing the real world situation formed the basis for an explosion of subsequent analysis.

The 1979 paper in the Journal of International Economics also sowed the seeds of an analysis of the forces driving increased urbanization. In his core-periphery model, which he developed properly in a 1991 publication, Krugman describes the opposing pressures that act on populations: those that serve to pull them into the core (urban) centres and those that work to push them out into the peripheral (agricultural) areas. For example, one such factor is the cost of transport, and the generally decreasing transport costs seen in the twentieth century have served to pull production, and populations, into urban centres. Once again, Krugman’s formulation of a robust model provided the apparatus that allowed a thorough exploration of the factors driving the global distribution of production facilities, and of the urbanization that is such a prevalent feature of the modern world.

By Adam Smith, Editor-in-Chief, Nobelprize.org
First published 20 October 2008

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