Effects of technological differences on international trade are best explained by the Product Cycle Model. This model regards technological innovation as the key determinant of the pattern of trade within the manufactured commodities trade. Product Cycle Model was developed by Raymond Vernon in 1966. Essentially, it is successor of the Imitation Lag Hypothesis that was introduced by Michael V. Posner in 1961. (…)
Essentially, the Product Cycle Model is related with the life cycle of a new product that is a manufactured commodity and its effects on international trade. According to the Product Cycle Model, many manufactured commodities produced with high technology undergo a trade cycle in conjunction with their production. There are two countries within the Product Cycle Model: One of them is the innovating country and the other one is the imitating country. The model analyzes the life and trade cycle of a new product manufactured by the innovating country.
The Model divides the life cycle of a new product into five stages.
The first stage is called new-product stage in which the product is produced and consumed only in the innovating country with skilled labor and high technology. The new-product stage is referred as 0X time frame on the horizontal axis. In the new-product stage, production is made only for the consumers of the innovating country with a small scale. There is no international trade in this stage. The innovating country would like to see the demand for the new product within the domestic market and take the responses and the feedback. Thus, production is performed as closer as possible to the consumer. Since the production requires skilled labor and high technology, the price of the new product is high.
The second stage is the product-growth stage, which is at the XV time frame. In this stage, production is increased in order to meet the rapidly increasing demand. In the product-growth stage, imitating country starts to demand the new product. Due to newly commencing foreign demand and domestic demand since its innovation, total demand for the new product rapidly rises. In this stage, production is performed only in the innovating country. Thus, the innovating country has a temporary monopoly power both in domestic and foreign market. This temporary monopoly power is enjoyed by the patent rights.
The third stage is product-maturity stage, which falls in the VY time frame. In this stage, the new product is standardized and the innovating country may give license to the imitating country to produce the product introduced by itself. Production in the innovating country reaches to its maximum level and the imitating country starts producing the new product to meet the domestic demand. At the end of this stage, imitating country becomes self-sufficient on the new product. In other words, it meets the domestic demand by domestic production.
The fourth stage is product-standardization stage, which coincides with the YZ time frame. In this stage, the new product is standardized. It is produced with lower costs of production in the imitating country and does no longer requires high technology within the production. Due to the lower costs of production, new product is relatively cheaper within the imitating country. In spite of the relatively higher costs, innovating country continues to produce the new product. However, the production within the innovating country declines due to the price competitiveness of the imitating country. Innovating country can no longer enjoy the brand competitiveness.
The fifth and the last stage is the product-decline stage, which refers to the time frame starting with Z. In the fifth stage, the production of the new product within the innovating country decreases rapidly since the imitating country undersells it in its domestic market. In other words, it becomes impossible for the innovating country to compete with the imitating country both in the domestic and international market. The exports of the imitating country expand rapidly since the innovating country begins to import the new product so as to meet the demand. Fast spread of technology, lower costs of production, and the standardization of the new product end up the life cycle of it.
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