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Krugman, Paul.1980."Scale Economies, Product Differentiation, and the Pattern
of Trade."AmericanEconomicReview,70(5): 950-59.
Theclassicaltheorythatforeigntradeisdetermined bycomparative advantage
failstoexplainsomeimportant observations, forexample,thatthereisconsiderable tradeinbothdirectionswithinwhatis usuallyregardedas a singleindustry,andthatcountriestendtoexportgoodsforwhichthedomesticdemandis
higher. Krugmaninvestigates thedetermination offoreigntradeunderincreasing
returns; he assumesno difference inproductionconditionsbetweencountries.
Pricesaredetermined byimperfect competitionwithcostlessproductdifferentiation.Usingsimplemodels,heformalizesforeigntrade.Whentransport costsare
introduced, heshowsthateachcountrywillspecialize,sonotwowillproducethe
samegoods.Thelargercountrywillhavetermsoftradeturnedinitsfavor,and
wageswillbehigherthere.Someextensions ofthemodelallowvarietieswithina
singleindustry. Itcanthenbeshownthatintra-industry tradecanemergeandthat
countrieswilltendtoexportthosecommodities forwhichthedomesticdemand
ishighest
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