Chapter 7 Increasing returns imperfect markets and trade theory This chapter discusses two major issues: explanations of trade patterns and gains from trade. The classical traditions were mainly concerned with gains from trade and other welfare effects. The theory of international trade is surveyed in the presence of economies of scale and monopolistic competition with an emphasis on predictions of trade patterns and gains from trade. The main ingredient of this logic is that the allocation of productive resources is guided in every country by the reward level of every sectors employed combination of factors of production. Economies of scale which arise from conglomeration or public intermediate inputs seem to be country specific and due to transportation costs within industry specialization in some stages of production are countries specific. It seems therefore that the size of a domestic industry plays a role in the determination of external economies of scale. But it is also clear that some sources of these scale economies affect more than a single industry which implies cross industry spillovers of external economies of scale. The chapter provides an overview on the general model of trade in homogeneous products when there are variable returns to scale and free entry into industries.