international economics

INTERNATIONAL ECONOMICSINTERNATIONAL ECONOMICSLecture 11 | Lucía Rodríguez| Scale, Competition and TradeLecture 11 | Lucía Rodríguez| Scale, Competition and Trade

SCALE, COMPETITION AND TRADE:SCALE, COMPETITION AND TRADE:MOTIVATIONMOTIVATION• The observed importance of intra-industry trade:

1. Traditional Trade Theory is no longer able to explain these patterns

Exports and Imports within sectors exhibit a tendency towards equalization rather than national specializationGrubel-Lloyd index indicates the relative importance of inter (tends to 0) vs. intra-

industry (tends to 1) trade

2. A new Trade Theory was needed to explain why similiar countries (in terms of technology, endowments,…) gain from trading with each other and why a significant part of that trade is made within the same industries.

Intra-Industry Trade: Balassa (1966) showed that the trade share of the dominant suppliers in an industry during the implementation of the EEC decreased in practically all industries

1X M

GLIX M

SCALE, COMPETITION AND TRADE:SCALE, COMPETITION AND TRADE:BASIC ASSUMPTIONSBASIC ASSUMPTIONS

• Economies of Scale:

CA is no longer the driving force behind International Trade The actual pattern of trade often reflects a created CA attributable to historical accidents or government intervention.

A. External Economies of Scale.

i. Firms continue to face rising marginal costs.

ii. However, if all firms in an industry expand output, costs for all of them, as a group, will go down

B. Internal Economies of Scale.

i. As a firm expands its production, cost per unit declines.

ii. As a result it may gain an advantage over other firms, both domestic and foreign, in producing a particular good or a particular variety of good.

Increasing Returns to Scale: Output grows proportionately more than the increase in inputs. Expanding output to serve a world market rather than a national market allows cost per unit to fall.


• External Economies of Scale:Causes

i. Specialized Inputs: can allow

ii. Common Pool of skilled Labor

Productivity to riseCosts to fall

A localized industrial cluster provides a large enough market for specialized services suppliers to stay in business.

The availability of this network of suppliers (example: Silicon Valley), keeps key inputs cheaper and more easily available.

No labor shortagesBetter matching and less unemployment

The concentration of firms in a single location makes it easier to switch employers

“It wasn’t that big a catastrophe to quit your job on Friday and have another job on Monday…You didn’t even necessarily have to tell your wife.”


• External Economies of Scale:Causes

iii. Spillovers of Knowledge: spread new technology Geographical concentration makes it easier to stay near the technological frontier

“If one man starts a new idea, it is taken up by others and combined with suggestions of their own, and thus becomes the source of further new ideas.”

A. MarshallUnit cost

Cumulative Output

L*

Co

C1

Q

L

The learning curve: unit cost is lower the greater the cumulative output of a country’s industry.

A country that has extensive experience in an industry may have lower unit cost than another with little or no experience.


• External Economies of Scale:Consequences.

i. Production with decreasing opportunity cost: inward bending

Y

XB

B’Increasing Returns to Scale:

Decreasing Opportunity cost:

Decreasing MRT



ii. Trade with decreasing opportunity cost.

Y

XB

B’

I

II

• Pre-Trade Equilibrium: A. With identical technology, endowment and preferences.• Trade allows complete specialization [B, B’]• If we allow a 1 to 1 exchange ratio, we reach a higher indifference curve. (otherwise the gains from trade will not be symmetrical: different barter lines and policy debates).

A



iii. The pattern of trade is not determined.

Price, cost

Watches

Demand

AC Thai

AC Swiss

1

2

Co

P1

Q1

• Thailand could potentially supply the world market more cheaply than Switzerland.• If the Swiss industry gets established first, it may be able to sell watches at price P1 which is below the cost Co that an individual Thai firm faces when beginning production.


• Internal Economies of Scale:

Figure 1. Unit Cost of Production

Increasing Returns to Scale: Output grows proportionately more than the increase in inputs.

Common in real-life situations: Existence of fixed costs, that get distributed over a larger number of units, as the output level increases.

Source: WTO World Trade Report 2008


• Previous theories anticipated the main concepts:A. Vernon Product Cycle

Domestic Production; Exports

t

Imports; Foreign Production

I II III IV

X-M

Dom Prod

For Prod

I. Product development and sales at home.a. Locating production close to buyers.b. R&D spending.c. Risk taking

II. Growth in X as foreign demand is cultivated.a. Cultivate foreign markets among similar

consumers.b. Start outsourcing.

III. Decline in X as production abroad begins to serve its markets.

a. Sales in some countries reach a threshold level.b. A certain degree of standardization has

occurred.IV. Home country becomes a net importer as foreign

prices fall.a. Foreign firms master production processes and

their cost fall as they increase production


A. Vernon Product Cycle:– International Trade is seen as a dynamic process, closely linked to

technological progress and firm behavior.– There is no CA linked to a specific relative factor endowment.– Different specialization patterns might imply different value added.– Policy decisions might shape the trade pattern via subsidies, trade

promotion,…


B. Preference Similarities:– As a rule, a nation will export manufactured products for which it

has a large and active domestic market, in order to achieve economies of scale and be competitive internationally.

– The most receptive markets for exports will found in those countries with comparable income levels and tastes.

Intuition: Income percapita shapes domestic taste, which in turn sets the domestic demand that will determine the final production.

If trade is allowed, there will be exchange of goods in which theere is an overlap in demand: Intraindustry Trade


Differentiated Products: The somewhat different products produced by different manufacturers in the same industry

International competition forces each firm in industrial countries to produce just a few varieties and styles of the same product in order to keep unit costs low.

SCALE, COMPETITION AND TRADE:SCALE, COMPETITION AND TRADE:ASSIGNMENTASSIGNMENT

• Evaluate the relative importance of economies of scale and comparative advantage incausing the following:– Most semiconductors are manufactured in either the US or

Japan.– Most of the world's aluminium is smelted in Norway or

Canada.– Much of the world's best wine comes from France.– Half of the world's large jet aircraft is assembles in Seattle.– Most Scotch whiskey comes from Scotland

SCALE, COMPETITION AND TRADE:SCALE, COMPETITION AND TRADE:MARKET STRUCTUREMARKET STRUCTURE

• External and Internal Economies of Sclae have different implications for the structure of industries– Internal Escale give large firms a cost advantage over small

ones and thus will imply imperfect competition.

• In a Perfect Competition set-up:– Firms are price-takers (no influence on prices).– Any individual firm represents only a tiny fraction of World

Market.

• In Imperfect Competition:– Firms are aware of their influence on prices (Boeing-Airbus)– Whenever there are only a few firms or produts are seen as

differentiated.– Different market structures emerge…

SCALE, COMPETITION AND TRADE:SCALE, COMPETITION AND TRADE:MONOPOLISTIC COMPETITIONMONOPOLISTIC COMPETITION

• Production:

Price

Quantity

DMC

Avg Total cost

• A firm faces a downward-sloping demand curve, as it has market power to set prices.•Price is no longer an indicator of the extra revenue from selling one more unit.• Optimal level of output where MC=MR. • The price consumers are willing to pay is given by their demand and represents mark-up over marginal costs.• P=ATC ensures no positive economic profit is made, because they would attract new entrants.MR

Q*

P*

SCALE, COMPETITION AND TRADE:SCALE, COMPETITION AND TRADE:MONOPOLISTIC COMPETITIONMONOPOLISTIC COMPETITION

• Trade:

Pr, AC

Number of firms

PC’

C

• Assume the same initial conditions: technology, endowments and preferences.• All firms will have the same costs and prices initially and the same number of producers will exist in autarky.• As we allow them to trade, industry rationalization will occur due to greater competition in an integrated market:

Fewer total firms in each country. Their Average output will be bigger. AC of production falls, as D increases. International Price will be smaller.P1

P

C

C’

P2PP line: Represents the relationship between the

number of firms and their ability to compete.

CC line: Represents the AC per firm increases with the number of firms as their size will decrease.

C’C’ line: As trade is allowed, the size of the market expands and more firms can exist without losing economies of scale

SCALE, COMPETITION AND TRADE:SCALE, COMPETITION AND TRADE:EMPIRICAL EVIDENCEEMPIRICAL EVIDENCE

• The Gravity Equation:– Developed by Timbergen (1962), to predict the pattern of

International Trade in absence of distortions.– The value of Bilateral Trade between two countries was an

increasing function of GNP of both countries (via export supply capacity and import demand).

– Trade flows were influenced negatively by the 'distance' between 2 countries, as a measure of transportation costs, language barriers, cultural factors and trade barriers.

– Useful in explaining bilateral flows and trade policies such as the creation of Free-Trade areas, yet it did not appear to offer any role to CA.

– Monopolistic approach was the first to provide a theoretical basis for this equation.

SCALE, COMPETITION AND TRADE:SCALE, COMPETITION AND TRADE:CASE STUDY: DUMPINGCASE STUDY: DUMPING

• Focus on the consequences of imperfect competition for international trade:

– The most common form of price discrimination in international trade is Dumping: the export price is lower than theone charged domestically.

– For Dumping to occur, two conditions must be met:• Imperfect competition: firms are price-setters• Market segmentation: domestic residents cannot easily buy goods

intented for exports

Firms do not necessarily charge the same price for goods that are exported than for goods that are sold domestically.


• Graphical example: A monopolist that faces a domestic

downward-sloping D. It can sell as much as it likes at the export

price. Since an additional unit can always be

sold at For P, the firm increases its output until For P=MC (1).

The quantity sold in the domestic market is given by the intersection of DomMR and For P (2).

Qdom implies a Dom P (3) higher than the export price.

General condition for price-discrimination: charge higher prices the higher the elasticity

Pr, C

Q

Dom DDom MR

MCDom P

For D= For MR

QmpQdom

12

3

For P

Dom Sales Exports


• Dumping is often seen as an unfair competitive practice:– Is price discrimination legitimate? Airlines discount to

students, senior cityzens, and so on.– In practice, since the 70s international complaints about

Dumping have been reported with increased frequency.– US Companies that claim to have been injured by firms that

dump their products, can appeal to the Commerce Department for relief.

– The International Trade Commission has to decide if there is unfair pricing that has caused injury.

– If the complaint is ruled valid, an antidumping duty is imposed, equal to the difference between the actual and 'fair' price of imports.

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