New Trade Theory (NTT): Definition & Analysis

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  • 0:01 Trade Theories in Action
  • 0:26 Traditional Trade Theory
  • 1:06 What Is New Trade Theory?
  • 3:13 Analysis of New Trade Theory
  • 4:54 Lesson Summary
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Lesson Transcript
Instructor: Beth Loy

Dr. Loy has a Ph.D. in Resource Economics; master's degrees in economics, human resources, and safety; and has taught masters and doctorate level courses in statistics, research methods, economics, and management.

In this lesson we'll discuss New Trade Theory. This theory tells us that trading patterns can be explained by economies of scale and network effects. We'll compare the theory to the Traditional Theory of International Trade and look at some examples.

Trade Theories in Action

You go to purchase a tablet computer, and you have several to choose from. You have choices of tablets made in the United States, Japan, China, and Taiwan. Why wouldn't you just have one choice, the one from the United States? You live in the United States, after all. Even though there are locally made tablets, there are also plenty of imported options. Why would this be? Trade theories attempt to do just that!

Traditional Trade Theory

To fully understand NTT, you should be familiar with the traditional theory that came before it. The free trade model, or the Traditional Theory of International Trade, explained that trading occurs because a country has inherent factors that make production cheaper. This theory is based on a perfectly competitive market structure. The comparative advantage, according to the theory, was simply because a country could produce the product at a lower price due to having a natural resource or favorable climate. It was not overly concerned with network effects or economies of scale. By contrast, with NTT, we know more than just geography guides which goods are purchased.

What Is New Trade Theory?

New Trade Theory (NTT) is an economic theory that was developed in the 1970s as a way to predict international trade patterns. NTT came about to help us understand why countries are trade partners when they are trading similar goods and services. This is especially true in key economic sectors like electronics, food, and automotive. We have cars made in the United States, yet we purchase many cars made in other countries.

These are usually products that come from large, global industries that directly impact international economies. Those tablets we talked about earlier are a perfect example. The United States both produces them and also imports them. NTT argues that, because of substantial economies of scale and network effects, it pays to export tablets to sell in another country. Those countries with the advantages will dominate the market, and the market takes the form of monopolistic competition.

Monopolistic competition tells us that the firms are producing a similar product that isn't exactly the same, but awfully close. According to NTT, two key concepts give advantages to countries that import goods to compete with products from the home country:

  • Network effects are the way one person with a good or service affects the value of that good or service to others. The value of the product or service is increased as the number of individuals using it increases. This is also sometimes called the bandwagon effect. Consumers like more choices, but they also want products and services with high utility, and the network effect offers increased utility to some goods and services over others.
  • Economies of scale are the situations where there are savings in costs that are gained by early entry into a market or an increased production capacity. It is also possible to benefit from this concept if entering a new industry with a lot of money and resources means that a company is able to quickly reach efficiency. The leverage formed by both of these core concepts has formidable effects on lowering the average cost of a unit produced, which means that some countries can still sell their products in other countries when they are so similar.

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