International Economics

Transcription

1 International Economics Vienna University of Technology Summer Semester 2006 Lecturer: Walter H. Fisher Economies of Scale, Imperfect Competition, and International Trade, Chapter #6, Krugman & Obstfeld

2 Krugman and Obstfeld, Chapter 6, 6th ed: Economies of Scale, Imperfect Competition, and International Trade (all equations and gures refer to the 6th edition.) Economies of Scale and Trade Previously, we have assumed that rms have constant returns to scale technology In this chapter Krugman and Obstfeld consider the implications of economies of scale. 1. furthermore, economies of scale can provide an incentive for greater international trade. Imagine that there are many goods subject to economies of scale in the US and the UK, numbered as 1, 2, 3, 4,...

3 To take advantage of economies of scale, countries must concentrate on producing only a limited number of goods. US : 1; 3; 5; ::: UK : 2; 4; 6; ::: If each country produces only some of the goods, then each good can be produced at a larger scale than would be the case if each country tried to produce everything and the world economy can produce more of each good. Consumers in both countries want both goods. International trade makes it possible for each country to produce a restricted range of goods and to take advantage of economies of scale without sacri cing variety in consumption. International trade leads to market structures other than perfect competition

4 External economies of scale in this case the cost per unit depends on the size of the industry a larger industry may permit more e cient provision of specialized services or equipment the size of the individual rms would be the same as before. Internal economies of scale in this case the cost per unit depends on the size of the rm; a rm is more e cient if its output is larger.

5 Market Structure Implications Under external economies of scale, the industry will consist of many small rms and tend toward competition. Under internal economies of scale, large rms have a cost advantage over small rms and lead to an imperfectly competitive market structure. both are important causes of international trade; we will discuss rst the case of internal economies of scale.

6 Theory of Imperfect Competition Perfect competition: there are many buyers and sellers and rms are price-takers, i.e., rms can sell as much as they want at the current price. Imperfect competition: in this market structure rms can in uence the prices of products they sell. They can sell more only by reducing price, These rms are known as price-setters.

7 Monopoly A monopolist faces a downward sloping demand curve. Marginal revenue is the gain from selling an extra unit marginal revenue is always less than price MR < P because to sell an additional unit, the rm must lower the price on all units. The demand curve of a monopolist (see Figure 6-1) : we can rewrite (6-1) as Q = A BP (6-1) P = A=B Q=B:

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9 thus, total revenue equals: R = (A=B)Q Q 2 =B: Di erentiating the latter expression by Q, we obtain the following expression for the marginal revenue, M R so that: MR = (A=B) 2Q=B = (A=B) Q=B Q=B = P Q=B (6-2) P MR = Q=B clearly, the price marginal revenue gap depends positively on Q (initial sales) and the (absolute value) of the slope of the demand curve.

10 Average (AC) and Marginal Cost (M C). Consider the following linear cost function C = F + cq (6-3) where F are xed and cq are variable costs. Average Cost AC = C Q = F Q + c: (6-4) Fixed costs in this example lead to economies of scale, because the larger the rm s output, the less is the xed cost per unit. Thus, AC falls, as is illustrated in Figure 6-1, since xed costs are spread over a larger output

11 Marginal Cost = c > 0; according to (6-3) marginal costs are constant, i.e., independent of the level of output. further, since AC MC = F Q > 0; average cost is greater than marginal cost. see Figure 6-2, which illustrates the case: C = 5 + c:

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13 Monopolistic Competition: a Special Case of Oligopoly Here, we deal with the case of internal economies of scale, where rms are large enough to a ect prices. Assumptions of Monopolistic Competition Di erentiated product product di erentiation assures that each rm has a monopoly in its particular product within an industry and is, therefore, somewhat insulated from competition. Monopolistic competitors take the prices of rivals as given. They ignore the impact of their prices on the prices of other rms. so even though each rm is in reality facing competition from other rms, it behaves as if it were a monopolist.

14 Let the demand curve for a monopolistically competitive rm take the following form: Q = S h 1=n b(p P ) i (6-5) where Q = rm demand (sales), S = total industry demand, n = number of rms in the industry, b = parameter measuring the responsiveness of rm sales to changes in its price, P = rm s price, P = average price charged rms in the industry.

15 If all rms charge the same price, P = P, each rm will have the same market share n 1. The model assumes that S is una ected by P. rms can gain customers only at the expense of others. this is an unrealistic assumption, according to Krugman and Obstfeld, but permits us to focus on competition among rms.

16 Market Equilibrium Firms are symmetric: demand and cost functions are the same for all rms The goal is to solve for the average industry price, P, and the number of rms in the industry, n. The relationship between AC and n: there is a positive relationship between the number of rms and AC: the more rms in a monopolistically competitive industry, the lower is the output for each rm, which implies that average cost, AC, depends positively on n. The positive relationship between AC and n is illustrated in Figure 6-3 by the CC locus.

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18 The relationship between P which all rms charge in equilibrium and n: the greater is n, the more intensive is the competition among rms, the lower is the average price in the industry. The negative relationship between P and n is illustrated in Figure 6-3 by the P P locus. If P > AC, then rms enter the industry; if P < AC, then rms leave the industry. To derive the CC locus, assume that all rms charge the same price: P = P ) Q = S n : Substituting into the average cost curve yields: AC = F Q + c = nf S + > 0: (6-6) so that the more rms in an industry, the higher is the average cost.

19 in other words, economies of scale cannot be take advantage of. To derive the P P locus, rewrite the demand curve of the monopolistically competitive demand curve: Q = S n + Sb P SbP treating P as given. Re-express as: so that total revenue equals P = 1 bn + P Q Sb 1 R = bn + P with marginal revenue, M R, corresponding to: 1 MR = bn + 2Q 1 P Sb = bn + P Q Q2 Sb Q Sb Q Sb = P Q Sb : (6-8)

20 Under pro t-maximization, marginal revenue equals marginal cost MR = P Q Sb = c = MC: Solving this expression for P, we obtain the pricing decision of the typical rm: P = c + Q Sb : (6-9) Substituting for the common market share, given by Q = S=n, we obtain an expression in terms of the number of rms, n: P = c + 1 nb : (6-10) thus, as the more rms in a monopolistically competitive industry, the lower the price. As indicated, this is illustrated in Figure 6-3 by the downward-sloping P P locus. In Figure 6-3 n 2 is the equilibrium number of rms in an industry: their common pro t-maximizing price is P 2, which is equal to the average cost, AC 2.

21 Limitations of the Monopolistic Competition Model 1. The monopolistic competition model describes relatively few industries; more common is small group oligopoly in which rms are aware that their actions in uence the behavior of the other rms in the oligopolistic industry. 2. Collusive behavior is excluded in the monopolistic competition model. 3. Strategic behavior is also excluded. An example of strategic behavior would be a rm that builds extra capacity to deter entrants, even though it has no intension to actually use the additional capacity.

22 Monopolistic Competition and Trade Consider again the CC curve AC = F Q + c = nf S + c: What happens if total sales increases? sales per rm will increase and the average cost of each rm will decline as a consequence the CC locus will shift down, which is illustrated in Figure 6-4. the number of rms n rises from n 1 to n 2, while the equilibrium price falls from P 1 to P 2. Consumers would prefer to be part of a large market rather than a small one, since a greater variety of products is available at a lower price at point 1.

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24 The general point is that international trade creates a world market larger than any of the national markets that comprise it. Integrating markets through international trade has the same e ects as the growth of a market within a single country.

25 Economies of Scale and Comparative Advantage Consider again Home and Foreign in the a two-factor and two-good framework. Home has a higher capital-labor ratio than Foreign, i.e., Home is capital abundant.. Now, however, manufacturing is no longer a perfectively competitive industry, instead, it is monopolistically competitive in which a number of rms produce di erentiated products. Krugman and Obstfeld, Ch.. 6, p. 137: Because of economies of scale, neither country is able to produce the full range of manufactured products by itself: thus, although both countries may produce some manufactures, they will produce di erent things.

26 If manufactures were not a di erentiated product sector, we recall from chapter 4: Since Home is capital abundant and manufactures capital intensive, Home has a relatively greater supply of manufactures and would, thus, export manufactures and import food. See Figure 6-6 for the pattern of trade in this case. If, instead, manufactures is monopolistically competitive, then Home would still be a net exporter of manufactures and an importer of food. However, Foreign will also produce di erentiated manufactured goods, distinct from those produced by Home. The pattern of trade will look like Figure 6-7 if manufactures are monopolistically competitive. The exchange of manufactures for manufactures is called intra-industry trade, while the exchange of manufactures for food is inter-industry trade.

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29 There are 4 things to keep in mind. 1. Inter-industry trade re ects comparative advantage: the pattern of this type of trade is that Home the capital abundant country is a net exporter of manufactures and a net importer of food, the labor intensive activity. 2. Intra-industry trade which is about 25% of world trade does not re ect comparative advantage. It is economies of scale that prevents the countries from producing the complete range of manufactures for itself. Thus, economies of scale can be an independent source of trade. 3. The pattern of intra-industry trade is not predictable. All we know is that countries will produce di erent products. Nevertheless, we still know the pattern on interindustry trade.

30 4. The relative importance of intra-industry trade depends on how similar the countries are. If Home and Foreign are similar in their capital-labor ratios the case for many advanced nations then there will be little inter-industry trade. Intraindustry trade based on economies of scale will be dominant. If, on the other hand, the capital-labor ratios are very di erent, so that Foreign completely specializes in Food, then there will be no intra-industry trade based on economies of scale. All trade will then be based on comparative advantage.

31 Dumping The practise of charging di erent customers di erent prices is called price discrimination. The most common form of price discrimination is called dumping: a pricing practise in which a rms charges a lower price for exported goods than it does for goods sold domestically. It is widely regarded as an unfair practise. Two conditions for dumping: 1. The industry must be imperfectly competitive, so that rms set prices rather than take them as given.

32 2. Markets must be segmented, so that domestic residents cannot easily purchase goods intended for export. See Figure 6-8 for an example: a single monopolistic rm sells in two markets, a domestic market where it faces the whole demand curve D DOM and a foreign market where it can sell as much as it wants at the price P F OR. To maximize pro ts, the rm must set marginal revenue equal to cost in both markets. To set marginal cost equal to marginal revenue in both markets, it is necessary to produce quantity Q MONOP OLY to sell Q DOM on the domestic market, and to export Q MONOP OLY Q DOM.

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34 The Theory of External Economies The famous economist Alfred Marshall o ered three reasons for external economies of scale. 1. specialized suppliers, re ecting the advantages of clustering in terms of creating a market of suppliers, 2. labor market pooling clusters of rms can create a pool of workers with highly specialized skills, 3. knowledge spillovers According to Krugman and Obstfeld, external economies of scale can cause countries to get locked into unfavorable patterns of trade and even lead to the loss of international trade. External economies also tend to reinforce the existing patterns of trade.

35 Assume that economies of scale are entirely external to rms in the watch industry. this implies that there are many small rms operating under competitive conditions, with competition, in turn, driving down the price to average cost, AC. Further assume that average cost is higher in Switzerland than it is in Thailand: AC T hai < AC Swiss. But what happens if the Swiss establish their industry rst? world equilibrium would then be at point 1 in Figure 6-9. with production Q 1. If the Thais were to take over the world market, the equilibrium would shift to point 2.

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37 But initial Thai production costs at C 0 are greater than the Swiss watch production costs at P 1. So although the Thai industry could produce watches more cheaply than the Swiss, the headstart enjoyed by the Swiss industry enables it to hold on to the market.

38 There is no guarantee that the right country will produce a good subject to externalities trade based on such externalities may even make it worse-o. In the example illustrated in Figure 6-10 the price of the good that Thailand imports would actually be lower if there were no trade and the country were forced to produce the good by it self. the country is then hurt with trade. This would seem to give Thailand the incentive to protect its watch industry. But identifying cases like the one illustrated in Figure 6-10 is di cult. which is the chief argument against an activist trade policy in this case.

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