- Person
- Paul Krugman
- Lived
- b. 1953
- Field
- Economics
- From
- American
The story
Traditional trade theory, going back to David Ricardo, explained trade by differences between countries: one with productive farms exports food, another with strong industry exports manufactured goods. But in the twentieth century an ever larger share of world trade took place between rich countries with similar conditions that buy and sell similar products. Sweden, for example, both exports and imports cars.
Paul Krugman had learned about models of monopolistic competition from a short course given by Robert Solow in 1976. In January 1978, as a young assistant professor at Yale, he visited his former adviser Rudi Dornbusch with a list of possible research ideas, including, almost as an afterthought, applying these models to trade. When Dornbusch flagged it as interesting, Krugman went home to work on it and, he recalled, knew within hours that he held the key to his whole career. He stayed up all night in excitement.
Convincing others took longer. A frustrating year and a half followed, with journal rejections and little interest from most senior colleagues. In the spring of 1979 the analytical trick that let him combine the idea with comparative advantage came to him at Boston's Logan Airport, and he presented the result at the National Bureau of Economic Research Summer Institute that July. He later called it the best 90 minutes of his life.
His model, published in the Journal of International Economics in 1979, rested on two assumptions: consumers like a wide choice of brands, and production is cheaper on a large scale. Car buyers want both Volvos and BMWs, yet it does not pay to build Volvos everywhere, so production concentrates in a few factories in a few countries. Trade lets each country specialise while consumers everywhere enjoy lower prices and more variety. Adding transport costs produced the home market effect: the country with the larger demand for a good tends to produce more than its share of it and export it.
Many models of international trade now follow Krugman's lead, building in economies of scale and a taste for variety. The approach became known as the new trade theory, and it formed a central part of the work honoured by his 2008 Nobel Prize.
Why it matters
New trade theory explains how trade gives consumers cheaper goods and greater variety, and reshaped how economists study globalisation.
About Paul Krugman
Nobel-winning economist who explained why similar countries trade and why industries cluster, then became America’s most widely read, and most argued-with, economic columnist.
More about Paul Krugman
- Paul Krugman modelled how currency crises happenAs a graduate student interning at the Federal Reserve, Paul Krugman wrote A Model of Balance of Payments Crises, explaining speculative attacks on currencies.
- Paul Krugman co-wrote the bible of new trade theoryWith Elhanan Helpman of Tel Aviv University, Paul Krugman wrote Market Structure and Foreign Trade, the book that brought the new trade theory together.
- Paul Krugman founded the new economic geographyIn a seminal 1991 paper, Increasing Returns and Economic Geography, Paul Krugman began the field that explains why industries and people cluster in cities.
- Paul Krugman co-wrote economics textbooks for studentsWith his wife, the economist Robin Wells, Paul Krugman wrote college textbooks on microeconomics (2004) and macroeconomics (2005).
Sources
- Incidents from My Career Paul Krugman, MIT
- Paul Krugman Jewish Virtual Library
- Paul Krugman Wikipedia
- The Prize in Economic Sciences 2008, Press release NobelPrize.org
Another act of tikkun olam. This is part of tikkun olam, the Jewish idea of repairing the world, and every one of us can add to it.