Information for the Public. This year's Laureate is awarded the Prize for his research on international trade and economic geography. By having shown the effects of economies of scale on trade patterns and on the location of economic activity, his ideas have given rise to an extensive reorientation of the research on these issues.Trade; Geography

Committee, Nobel Prize

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Research Papers in Economics

1 (4) The Prize in Economic Sciences 2008  The Royal Swedish Academy of Sciences  www.kva.se
The Prize in Economic Sciences 2008
I NFORMATION  FOR  THE  PUBLIC
This year’s Laureate is awarded the Prize for his research on international trade and economic geo-
graphy. By having shown the effects of economies of scale on trade patterns and on the location of eco-
nomic activity, his ideas have given rise to an extensive reorientation of the research on these issues.
International Trade and Economic Geography
How are we affected by globalization? What are the effects of free trade?  Why do increasing 
numbers of people ﬂ  ock to large cities, while rural areas become depopulated?
These questions cannot be answered without a theoretical foundation. For a long time, the 
analysis of foreign trade had been based on a well-established theory which explained why 
some countries export certain goods and import others. After World War II, however, it 
became increasingly obvious that important trade patterns did not quite correspond with that 
theory. In 1979, the US economist Paul Krugman proposed a new model which provided a 
better explanation for the observed patterns.
In later research, Krugman has shown that the model he initially developed for international 
trade could also be used to clarify key issues in economic geography. In the context of both 
foreign trade and economic geography, the objective is to explain what goods are produced 
where. Theories of economic geography also attempt to specify the forces whereby labor and 
capital become located in certain places and not others.
Traditional Foreign Trade
In the early 1800s, the English economist David Ricardo launched the theory of so-
called comparative advantage to explain the range and composition of international trade. 
This theory, which was extended during the 1920s and 1930s by the Swedish economists 
Eli Heckscher and Bertil Ohlin, implies that foreign trade is based on differences among 
countries. Ricardo studied countries which differ in terms of technology. Heckscher-Ohlin 
considered countries which differ in terms of access to factors of production; some countries 
have a relatively abundant supply of labor but a scarcity of capital, whereas the opposite pre-
vails in other countries. The result is that some countries should specialize in and export, for 
example, industrial products and import agricultural products – and vice versa.
Since its inception, this theory seemed capable of explaining the vast majority of international 
trade. Over the last half century, however, researchers observed increasingly large deviations 
from the trade patterns predicted by Ricardo and Heckscher-Ohlin. So-called intra-industry 
trade has expanded, in particular between rich countries. Such trade implies that a coun-
try both exports and imports more or less the same goods. A country such as Sweden, for 
example, exports and imports cars. This would not be compatible with the theory of compara-
tive advantage unless the production of Volvo cars required a wholly unique technology, or a 
completely different combination of labor and capital than, for instance, production of BMW 
cars. But this appears highly unlikely.2 (4) The Prize in Economic Sciences 2008  The Royal Swedish Academy of Sciences  www.kva.se
Almost 30 years ago, Krugman introduced an entirely new theory of international trade. It 
was intended to explain the occurrence of intra-industry trade and was based on an assump-
tion of economies of scale whereby mass production diminishes the cost per unit produced. 
The basic idea is rather self-evident, but the step from speculation to a stringent and cohesive 
theory is  substantial – and this was precisely the step Krugman took in his short, 10-page 
article in the Journal of International Economics in 1979.
Consumers Appreciate Diversity
In addition to economies of scale in production, Krugman’s new theory was based on an 
assumption that consumers appreciate diversity in their consumption. At the time, this was a 
rather new concept in economics, but it appeared to correspond to reality. Indeed, most of us 
have witnessed greater diversity in the supply of available commodities. As consumers, we are 
constantly tempted by a growing number of brands, even though we might sense that a stan-
dard car, a standard pair of jeans or standard toothpaste would sufﬁ  ce. After our basic needs 
for food and housing have been satisﬁ  ed, it seems as if we opt for diversity and variation in 
our consumption. Two years earlier, in 1977, Avinash Dixit and Joseph Stiglitz had published 
a model for analyzing consumers’ preferences for product diversity. According to this model, 
each producer, working under increasing returns to scale, becomes more or less a monopolist 
in terms of his own brand, even though he is subject to sharp competition from other brands. 
Such a model can be used to show that foreign trade will arise not only between countries 
which are different (as in the traditional theory), but also between countries which are iden-
tical in terms of access to technology and factor endowments. Moreover, it can be demon-
strated that extensive intra-industry trade will occur. In fact, it becomes advantageous for a 
country to specialize in manufacturing a speciﬁ  c car, and to produce it for the world market, 
while another country specializes in a different brand of car. This allows each country to 
take effective advantage of economies of scale, thereby implying that consumers worldwide 
will beneﬁ  t from greater welfare due to lower prices and greater product diversity, as com-
pared to a situation where each country produces solely for its own domestic market, without 
international trade.
Krugman’s initial article is brief and straightforward. Owing to its simplicity, the interna-
tional research community could quickly ascertain that it pointed to vital mechanisms in 
the economy. In many subsequent articles and books, Krugman himself, as well as other 
researchers, have endowed the theory with greater realism. Today, the general view is that 
the basic mechanisms speciﬁ  ed by Krugman constitute an important complement to the 
traditional Heckscher-Ohlin theory. The truth, as in so many other instances, is that reality 
encompasses features of both theories. This has resulted in lively empirical research aimed 
at determining the extent to which foreign trade can be explained by the earlier theories as 
compared to the new theory. In general, the new theory of international trade has inspired 
an enormous ﬁ  eld of research, which is usually a reliable indication of theoretical quality.3 (4) The Prize in Economic Sciences 2008  The Royal Swedish Academy of Sciences  www.kva.se
Economic Geography
Economic geography deals not only with what goods are produced where, but also with the 
distribution of capital and labor over countries and regions. The approach Krugman used in 
his foreign trade theory – the assumption of economies of scale in production and a prefe-
rence for diversity in consumption – was also found to be appropriate for analyzing geograp-
hical issues. This allowed Krugman to integrate two disparate ﬁ  elds in a cohesive model.
The embryo of the theory which would come to be called the “new economic geography” 
had already appeared in Krugman’s 1979 article. In the ﬁ  nal pages, he asks what would 
happen if foreign trade became impossible, for instance due to excessively high transport 
costs or other obstacles. His line of reasoning is as follows. If two countries are exactly alike, 
then welfare will be the same in both countries. But if the countries are alike in all respects 
except that one of them has a slightly larger population than the other, then the real wages 
of labor will be somewhat higher in the country with more inhabitants. The reason is that 
ﬁ  rms in the more highly populated country can make better use of economies of scale, which 
implies lower prices to consumers and/or greater diversity in the supply of goods. This, in 
turn, enhances the welfare of consumers. As a result, labor, i.e., consumers, will tend to 
move to the country with more inhabitants, thereby increasing its population. Real wages 
and the supply of goods will then continue to increase even more in that country, thereby 
giving rise to further migration, and so on.
Twelve years would pass, however, before Krugman reconsidered these ideas. In an article 
published in 1991, he developed these concepts into a comprehensive theory of location of 
labor and ﬁ  rms. Here, he assumes that although trade is possible, it is obstructed due to 
transport costs. Otherwise, labor is free to move to the country or region which can offer 
the highest welfare, in terms of real wages and diversity of goods. Firms’ location decisions 
imply a trade-off between utilizing economies of scale and saving on transport costs.
Concentration or Decentralization?
The above considerations evolved into the so-called core-periphery model, which shows that the 
relation between economies of scale and transport costs can result in either concentration 
or decentralization of communities. Under certain conditions, the forces which contribute to 
concentration will dominate. Regional imbalances arise and most of the population will be 
concentrated in a high-technology core, whereas a small minority will inhabit the periphery 
and live off agriculture. Such a mechanism could underlie the explosive urbanization witnes-
sed today throughout the world, with rapidly growing megacities surrounded by increasingly 
depopulated rural areas. This is not necessarily the only possibility, however. Under diffe-
rent conditions, the forces which give rise to decentralization will dominate. This promotes 
somewhat more balanced development. Krugman’s model can be used to account for the 
mechanisms at work in both directions. For example, his model indicates that declining trans-
port costs easily generate concentration and urbanization – which seems particularly notewor-
thy since transport costs have exhibited a declining trend throughout the twentieth century.4 (4) The Prize in Economic Sciences 2008  The Royal Swedish Academy of Sciences  www.kva.se
Other Endeavors
In addition to his scientiﬁ  c research, Paul Krugman is highly appreciated by his students 
as a pedagogical lecturer and author of textbooks. In wider circles, he is better known as a 
lively blogger and spirited columnist in the New York Times.
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LINKS AND FURTHER READING
More information about this year’s prizes, including a scientiﬁ  c background article, is to be found at the Royal 
Swedish Academy of Sciences’ website, www.kva.se, and at http://nobelprize.org. You can also see the press 
conference there as web-TV. Further information about exhibitions and activities concerning the Nobel Prizes 
is available at www.nobelmuseum.se.
Selected Scientific Articles
Krugman, P (1979) Increasing Returns, Monopolistic Competition, and International Trade, Journal of Interna-
tional Economics 9: 469–479.
Krugman, P (1980) Scale Economies, Product Differentiation, and the Pattern of Trade, American Economic 
Review 70: 950–959.
Krugman, P (1991) Increasing Returns and Economic Geography, Journal of Political Economy 99: 483–499.
Popular Science literature
Krugman, P  (2000) Geography and Trade, MIT Press, Cambridge, MA. 85 pp.
Krugman, P & Obstfeld M (2009) International Economics: theory and policy, 8th edition, Pearson. Ch 6–7, 712 pp.
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THE LAUREATE
Paul Krugman
Woodrow Wilson School of Public and International Affairs
Princeton University
Princeton, NJ 08544-1013
USA
 
wws.princeton.edu/people/display_person.xml?netid=pkrugman&
US citizen, born 1953 in New York, NY, USA. Ph.D. 1977 from Massachusetts Institute of Technology, Cambridge, 
MA, USA. Since 2000, Professor of Economics and International Affairs at Princeton University, NJ, USA.

Paul Krugman: International Trade and Economic Geography

http://www.nobelprize.org/nobel_prizes/economics/laureates/2008/popular-economicsciences2008.pdf

Paul Krugman: International Trade and Economic Geography

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