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Paul Krugman is a professor of economics at Princeton University and an American economist. Krugman is a leading liberal voice in American policy debate, and this has given him the label of one of the most influential academic thinkers in America. In 2008, in recognition of his work on international economics, he was awarded the Nobel Prize in economics. Krugman was born on February 28, 1953 in Albany and was raised in the county of Nassau (Krugman, 1991). He attended John F. Kennedy high school. Later on, Krugman joined Yale University and graduated with B.A. summa cum laude in economics. In 1977, he did a Ph.D. from the Massachusetts Institute of Technology (MIT) under Rudi Dornbusch guiding him on his thesis. Being a prolific writer, he published 200 papers in a professional journal and over 20 books. This paper discusses Paul Krugman’s biography and his economic theories as well as their contributions to economic thoughts.
Krugman began working on a new monopolistic and internal trade competition. Later on, he developed and popularized various works on a new trade theory. His contributions were to create awareness that trade can increasingly be explored not only by comparative advantage but also by concentrating regionally and involving the economies of scale. Notably, he also explained the significance of consumers’ preferences for diversity. Evidently, one of the fields where his expertise is seen is the new trade theory. Krugman is supportive of globalization and free trade. The new trade theory evolved into the new economic geography (NEG) (Krugman, 1991). Some of the top universities where Krugman has worked include London School of Economics, Princeton University, and MIT. In 1982, Krugman spent one year under the supervision of Presidency of Ronald Reagan working for the Council of Economic Advisers.
Economic Theories and Contributions to Economic Thought
The Theory of Everything
The first theory is the theory of everything whose author is Paul Krugman. This theory outlines the changes and advancements that are seen in the financial world with upcoming middle-class countries shooting in terms of income for instance, (China) while those ordinary persons in well-developed countries (U.S.A.) are not doing so well (Krugman, 1997a). In the 1990s, Krugman developed the new economic theory alongside U.K.’s Anthony Venables and Japan’s Masahisa Fujita. Talking about the new economic geography theory, it is about cities and explains employees’ desire to be near their employer and companies’ craving for a closer bond with their customers. Apparently, this explains the natural reason for firms and individuals to be near each other. In this theory, companies have economies of scale, and Krugman argues it is better to build few big plants than several little ones (Krugman, 1997a). As cities grow, the economy grows as well and gets richer. Eventually, the city reaches a critical mass, and another city develops and grows rapidly. Lastly, several cities develop with growth in the economy.
The theory of new economic geography tells a frustrating and hopeful story. It is hopeful because the blessings of industrialization will eventually spread to every continent on earth and individuals have to wait (Krugman, 1997a). On the other hand, it is frustrating because the spread will take many years even when countries do all things the right way; they are supposed to wait for their turn. This theory also suggests that globalization process will periodically generate income, especially in rich countries, to temporarily grow slowly or perhaps decline prior to resuming their upward climb. Apparently, this might cause periodic waves that can derail globalization. For example, much growth in China’s economy might have slowed the economic growth in the USA, Europe, and Japan (Clark, Feldman, & Gertler, 2000). As a result, the most important contribution is that it brings hope for faster industrialization and cause income growth to slow down in wealthy countries.
The New Trade Theory
The new trade theory by Krugman explains the importance of continued trade between countries producing related goods and services in spite of the fact that they will gain nothing. The theory also argues that comparative advantage does not result from differences in climate and resources but the “economies of scale and network effects” (Krugman, 1997b). Although there may be no disadvantage for a country to produce an absolute good, it may prefer to import goods from another country and specialize in the production of other products to attain economies of scale that maximize production and minimize cost. As a result, this leads to cheap variety of goods globally and leaves the customer with no range of products, but production of similar goods by different countries increases a variety of the customers.
The new trade theory replaced the international trade theory which had its focus on comparative advantage and unlimited trade (Krugman, 1991). In these theories, each country had a comparative advantage over other countries in the manner of goods and services produced at a cheaper cost than any other. Suggestions from the theory show these relative benefits to result from climate or natural resources. In addition to climate and natural resources, a factor such as specialization is also seen to lead to the comparative advantage. Thus, it then makes it easier for any country to specialize in only some particular goods.
Secondly, the theory explains the costs of “economies of scale and globalization” to developing countries (Krugman, 1997a). According to the theory, early entrants into an industry always have an intrinsic advantage in that industry. It is difficult for new businesses to compete as the beginning of the entrants has additional time to reach economies of scale. As a result, this makes it difficult for emerging firms in developing countries to get established in the already existing international market as those already developed dominated the market with the recognized economies of scale. Consequently, this makes it difficult for the established entrants to face competition from the new firms, and they continue to dominate the market for their established economies of scale. Thus, this brings a significant challenge for new or upcoming companies to enter the global market.
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The new trade theory also offers an insight into the topic of government regulation where the government should intervene in protecting upcoming industries by allowing domestic subsidization for them to fully exploit economies of scale and become more competitive in the global market (Krugman, 1997a). The reason is that the comparative advantage is also linked to the government as well as market-created factors and intervention by the government would help new firms to be competitive in the market.
The Interstellar Trade Theory
This theory expands “interplanetary trade” theory to an interstellar setting. The theory explains how trade can take place between two planets that are widely separated, for instance, Trantor and earth. This kind of trade will simply be affected by the relativity theory where living beings on earth (or Trantor) will see time passage at speeds that are varied from those beings who are on board cargo ships that are still moving between the two planets (Weeks, 2014).
The theory focuses on the determinants of genuine interest rates, showing how time dilation transforms the implication of time preference. As people move close to the speed of light, they get into the future with a stationary observer, for instance, “take a very rapid spaceflight, and come back to earth many years later as a billionaire? Hardly any time has passed for you” (Krugman, 1997b). In this quote, Krugman talks about eliminating time preferences or, on the other hand, letting people lower their time favorite by spending cash on fuel. In such state, the real interest rate cannot exceed the costs at which more fuel can propel a person into the future through time dilation. This theory illustrates that time is meaningless, and the rate of interest should correspond to the total cost of making the trip.
Krugman later devised two fundamental theorems of interstellar theory. According to the first theorem, Krugman’s argument was that the interest cost of goods on transit should only be calculated with the aid of clocks on planets but not ships. The reason is that the opportunity cost of the trade is calculated using bound planet clocks, not considering the effect of relativity on a businessman who is traveling together with his cargo (Clark, Feldman, & Gertler, 2000). Krugman’s second theorem states that although time of long travel means the prices on the trading planets will by no means reach parity, the rates of interest will vary. In case they are at variance, the investors can buy bonds on the planet that is more attractive driving its rates back to equality with those of its partners in trade.
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In conclusion, Krugman’s theories have contributed positively towards today’s economy. Krugman made a lot of contributions in the economic world, and most of his theories shed more light on economics and the way to maximize economies of scale. The theory of everything explains in conjunction with new economic geography the natural reason for companies and customers to collaborate and the need to have few large plants than several small ones. Companies have economies of scale, and when cities grow, economy gets richer leading to industrialization and slow growth in developed countries. The new trade theory shows the importance of countries to produce similar goods to allow variety in the global market as well as the government taking regulation and protecting new firms on production to enable them to exploit economies of scale and become competitive in the market. Lastly, the theory interstellar explains the peculiarities of trade between two planets where two theorems apply to support the theory.