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1、Feenstra,AdvancedInternationalTradeChapter5:IncreasingReturnsandtheGravityEquationInthischapter,wemakeasignificantdeparturefromearliertrademodelsbyallowingforincreasingreturnstoscale.TheideathatincreasingreturnsmightbeareasonfortradebetweencountrieswaswellrecognizedbyBertilOhlin(1933)andalsoFran
2、kGraham(1923),andhas1beenthemotivationforpolicyactions.InCanada,forexample,extensivepolicydiscussionsinthe1960sarguedthatCanadianfirmswouldbenefitfromunrestrictedaccesstotheU.S.market.ItwasbelievedthattheCanadianmarketwastoosmalltoallowmanufacturingindustriestooperateataminimumefficientscale,and
3、thatwithaccesstotheU.S.market,firmscouldmove2downtheiraveragecostscurves,whichisagaininefficiency.Indeed,thiswasaprincipalreasonthatCanadaenteredinafreetradeagreementwiththeUnitedStatesin1989:togiveitsfirmsfreeaccesstothelargeAmericanmarket.Aspromisingasthislineofargumentis,however,itcontainsapu
4、zzle:asfirmsinCanadaandtheU.S.movedowntheiraveragecostcurvesduetoaccesstotheothermarket,surelynotallfirmscanexpandoutputthatmuch,sincewhowouldbuyit?Thus,anexpansionbysomefirmsseemstosuggestthatotherswillneedtoexitthemarketentirely.Soweneedamodeltosortoutthesevariouseffects.Themodelthatismostsuit
5、edtothispurposeisoneofmonopolisticcompetition:amarketwithalargenumberoffirms,eachproducingauniquevarietyofadifferentiatedproduct,withfreedomofentryandexit.ThismodeldatesbacktoEdwardChamberlin(1936)andJoanRobinson(1933)whopresentedgraphicalanalyses.Thewidespreaduseofthismodelhadtowaitforamathemat
6、icalformulation,however,whichwasachievedbyLancaster(1975,1979),1Graham(1923)arguedthattradeduetoincreasingreturnstoscalemightbeanargumentforprotection,i.e.thatonecountrycouldlosefromtrade.Ethier(1982)analyzedamodelofthissort,relyingonincreasingreturnsthatareexternaltothefirm.Inthischapterwewillf
7、ocusexclusivelyonincreasingreturnsthatareinternaltothefirm.2See,forexample,EastmanandStykolt(1960,1967).5-2Feenstra,AdvancedInternationalTradeSpence(1976),andDixitandStiglitz(1977).Lancasterpresentedamodelinwhichconsumersdif
