Perfect Competition and Intra-Industry Trade
24 Pages Posted: 19 Jul 2009
Date Written: July 17, 2009
The paper presents a formal study of how risk aversion can be applied to analysis of international trade. It seeks to illustrate, amongst other things, that risk-averse firms operating in perfectly competitive markets with uncertainty of demand tend to diversify markets and that this provides the basis for international trade in identical commodities between identical countries. The paper argues that such trade may be welfare-improving, despite efficiency losses due to cross-hauling and transportation costs. Moreover, the analysis shows that reduction of tariff per unit of imported goods (e.g., due to the organization of custom unions) increases trade flows but does not necessarily improve total welfare. Therefore, in some particular cases, the use of sophisticated government intervention can lead to better outcomes than can free trade.
Keywords: reasons for trade, intra-industry trade, demand uncertainty, risk aversion, market diversification
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