MOVEMENT OF INTRA-INDUSTRY TRADE INDEX IN TERMS OF EXCHANGE RATE CHANGE: THEORETICAL ANALYSIS BASED ON A TWO-STAGE PRODUCTION MODEL

Abstract

This paper analyzes the movement of intra-industry trade index when the exchange rate or the world price changes. In our two-stage production model, firms construct factories in a foreign country by foreign direct investment (FDI). The firms export components from the home country to the foreign factories, and import final products from the foreign factories. The foreign factories also sell the final products in the world market. Under this knockdown system, we research the movement of the intra-industry trade index of the home country. This paper shows that appreciation of the exchange rate does not always raise the intra-industry trade index. We also show that changes in the world price have the similar effect on the movement of the intra-industry trade index.