New Trade Theory

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New Trade Theory

The New Trade Theory (NTT) was developed by Paul Krugman in the 1970s to explain the prediction into the patterns of the international trade. Moreover, the theory explains how two countries which produce similar goods and services become beneficial trading partners; which the traditional comparative advantage theory by David Ricardo failed to explain. Unlike the traditional theories that argue constant returns to scale, the New Trade Theory advocates for increasing returns to scale. This theory argues that network effects and economies of scale are the determinant factors of patterns in international trade. In a case where the effects of these two factors are intense, the comparative theory is outweighed in the sense that, at a given point in time, two countries may not exhibit any significant differences in opportunity cost. This theory further explains that early entrants in the market tend to dominate the market and hence enjoy the benefits of economies of scale. As a result a monopolistic competition market structure exists, where competition is limited.

The arguments of the New Trade Theory lead to the conclusion that countries with intensive capital to finance early entrance into the market of the lucrative industries have competitive advantage over the others. This means that the developed countries enjoy the economies of scale in most of the industries unlike the developing countries which tend to lag behind due to capital constraints. This theory encourages international trade for profit maximization and also explains the benefits of the rise of globalization.


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