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Decreasing Costs in International Trade and Frank Graham's Argument for Protection

Wilfred J. Ethier

Abstract

Over half a century ago Frank Graham argued that decreasing costs could justify protection. Although this contention stimulated a huge literature, a correct analysis has never been made. The present paper attempts to fill this gap. It is shown that Graham's case applies to trade between approximately equally-sized economies and that a greater degree of increasing returns actually reduces its likelihood. Furthermore, increasing returns yield a positive analysis nearly completely symmetric to that of Ricardian constant costs. A new analytical tool, the allocation curve, is introduced, with which Marshallian stability is fully analogous to Walrasian instability with offer curves.