"New" macroeconomics (1)

   In "hi, economics", I have written articles using various economics concepts. But regular readers may have noticed -- I use or analyze much more microeconomic concepts than macroeconomic (yet due to the pandemic, I have written several pieces on macro). Other readers may also get this from other occasions: I had ever taught microeconomics and now I mainly teach macroeconomics although I like microeconomics more than macroeconomics.
   Having said that, I don't dislike macro but my interest in macro, especially the basic level of macro, is lower than micro. However, I in fact like the more advanced level of macro -- the "new" macroeconomics developed since late 1970s. Sadly, "new" macro is not taught at the basic course even though it is extremely influential in macroeconomists' mind. All new economics PhDs simply learn "new" macro in graduate school, almost no any "old" macro as what readers of "hi, economics" are normally familiar with.  Due to this reason, I would like to briefly introduce some concepts of "new" macro to the readers of "hi, economics".
   Roughly speaking, "new" macro started from late 1970s and includes three major developments: "new" trade theory, "new" growth theory and "new" economic geography. All the three major developments are due to the realization of scale economy at the macroeconomic level. So, you can see: scale economy is a microeconomic concept but its application in macro is profound. That's also the reason why I like "new" macro: I like micro and "new" macro is an exploration of a micro concept in macro.
   Let us revisit the concept of scale economy or increasing returns to scale. If we produce more but the per unit cost of the producing the good is declining, there is scale economy. Why there is a scale economy? Increasing return is an important reason. If we increase the employment of all inputs by the same proportion but output will increase by more than this proportion, there is an increasing return to scale.
   At the micro level, we can have scale economies for some goods. For example, suppose the average cost curve is U-shaped. For those goods where production is at the downward sloping side of the curve, there exist scale economy for these goods. At the macro level, however, we may not think that scale economy is a relevant concept. If the concept is relevant for macro, this means that most goods in the economy exhibit scale economy. Nevertheless, if so many goods involve scale economies, the whole economy's output can be greatly improved simply by employing more resource. Why don't we, then, do this (employing more resource) exactly? Failing to exploit this gain, the economy is indeed at a state of massive waste of resource. Traditional economists do not believe that this is a realistic situation as market competition in the real world is intensive. With keen competition, economists believe that there should be no massive waste of resource (although some wastes are possible). Meanwhile, we also do not see aggregate output can be so easily greatly increased by increasing some more resource employed. Taken together, scale economy must not be relevant at the macro level (though may exist at micro level).
   This traditional belief started to change since late 1970s. What happened in late 1970s? There might be many things happening that changed economists' belief. But now it is not controversial to agree that Paul Krguman's (Nobel prize for economics in 2008) paper in 1979 on international trade is a truly influential one that helps reverse economists' belief. What this paper is about? I will touch on this in the next post.