Transcript International Trade - Haas School of Business

BA 187 – International Trade
Increasing Returns to Scale,
Imperfect Competition & Trade
Economies of Scale & Market Structure
•
Increasing Returns to Scale (IRS) means that equal proportionate
increase in inputs to production results in a more than equal
proportionate change in output.
– This implies cost per unit for output falls as output rises.
•
Two ways for this to occur:
•
External Economies to Scale
– When cost per unit for output depends on size of the industry but not on
the size of any one firm. (Think knowledge spillovers.)
– Typically results in industry of many small firms acting as perfect
competitors. (Think Silicon Valley, Multi-media Gulch, etc.)
•
Internal Economies of Scale
– When cost per unit for output depends on the size of the individual firm
but not necessarily on the size of the industry. (Think Natural Monopoly)
– Typically results in advantage to few, large firms acting in imperfectly
competitive manner. (Think Regulated Utilities, Microsoft, etc)
2
PPF & Gains to Trade with RS
1. Assume PPF same for both nations & exhibits Increasing
Returns to Scale. This means PPF is bowed inward towards origin.
Good Y
2. In autarky, nations produce & consume at point A.
3. If each nation specializes in one of the goods and then
trades to reach pt. E, both achieve higher utility.
QY
4. Pattern of trade is indeterminate, either nation
can specialize in either good.
E
UTrade
A
UAut
PPF
with IRS
QX
Good X
3
Strategic Trade with IRS
Good Y
QY
E1
PPF
1. Assume PPF same for both nations & exhibits IRS.
2. Assume that international terms of trade given.
3. Pattern of trade is technologically indeterminate,
either nation can specialize in either good.
4. Nation is not indifferent between which good it
produces. Will want to specialize in Good Y, as
this results in highest utility.
5. Still mutual gains from trade but now strategic.
U1Trade
E2
U2Trade
QX
Good X
4
Older Approaches to Trade Patterns
Product Cycle and Linder Demand
Theories
Product Cycle Models
• Based on presumption that introduction of new product conveys
temporary monopoly in market.
– New product requires highly skilled labor to produce
– As product matures, it becomes standardized or can be imitated.
– Comparative advantage shifts from innovating nation to nations with cheap labor.
• Technological Gap model emphasizes time lag in imitation.
•
Product Cycle model emphasizes standardization process.
Stage I: New Product Phase – Produced/consumed in innovating country only.
Stage II: Product Growth Phase – Rising demand at home & abroad leads to exports
from innovating country.
Stage III: Product Maturity Phase – Product standardized, prod’n licensed to others.
Stage IV: Imitation I Phase – Imitating country undersells originator in ROW.
Stage V: Imitation II Phase – Imitating country undersells in originator’s market.
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The Product Cycle Model
Quantity
Stage I
Stage II
Stage III
Stage IV
Stage V
Consump.
Exports
Imports
Prod’n
Innovating
Country
Prod’n
Exports
Consump.
Imitating
Country
Imports
Time
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Dates of Product Introduction &
Characteristics of Industry 1970-1979
Date of Product Introduction
Prior to
1930
19301949
19501954
19551959
19601964
19651969
After
1969
0.5%
3.0%
5.0%
6.9%
7.7%
10.8%
18.1%
R&D Expenses as
% of Revenue
1.3
2.2
3.2
2.6
3.8
4.3
5.4
Marketing
Expenses as % of
Revenue
6.8
7.4
8.5
7.9
9.4
10.5
10.5
Industry Exports as
% of Industry sales
8.7
7.9
9.6
10.0
10.0
8.5
13.0
Industry Imports as
% of Industry sales
7.0
5.3
3.7
4.2
4.5
3.9
4.0
Characteristic
Real Market
Growth %
Source: Thorelli & Burnett, “The Nature of Product Life Cycle for Industrial Goods Business”
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Linder Demand Theory
• Linder Theory focuses on role of demand, rather than
supply, on trade patterns.
– Assumes consumers’ tastes depend on their income levels.
– A nation’s income level yields pattern of demand for goods.
– The nation’s produce types of goods demanded within country,
hence nation’s production reflects its income level.
• Trade between countries occurs in goods for which there is
overlapping demand, i.e. consumers in both countries have
a demand for these particular items.
– Implies that trade in certain goods should be more intense between
countries with similar per capita income than between countries
with dissimilar per capita incomes.
– Consistent with product cycle model.
– Consistent with empirical evidence generally & for manufactures
in particular.
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Per-Capita Income Demand Patterns
Food
Clothing
Rent &
Power
Medical
Care
Education
Transport &
Commun
Other
Consumer
U.S.
13%
6%
18%
14%
8%
14%
27%
Japan
16
6
17
10
8
9
34
Argentina
35
6
9
4
6
13
26
Korea
35
6
11
5
9
9
25
Thailand
30
16
7
5
5
13
24
Cote d’Ivoire
40
10
5
9
4
10
23
Pakistan
54
9
15
3
3
1
15
Zaire
55
10
11
3
1
6
14
High-Income
Upper
Middle Inc.
Lower
Middle Inc.
Low-Income
Source: World Bank, World Bank Development Report, 1990
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Linder & Intra-Industry Trade
• Linder theory does not identify the direction in
which any good flows.
– In fact, a good might be traded in both directions.
– This was not possible in previous models.
• Intra-Industry trade:
– Occurs when country imports and exports items in the
same product classification.
– Linder predicts this trade should be greatest between
countries with similar per capita income levels.
– Why Intra-industry trade?
• Product Differentiation plus IRS can lead to each country
specializing in particular variants for the joint “mass market”.
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Intra-Industry Trade
• Index of Intra-Industry Trade
IIIT = 1 – |X-M|/(X+M)
– No IIT then IIIT = 0, All IIT then IIIT = 1.0
• Why Intra-Industry Trade in an Industry?
–
–
–
–
–
Product Differentiation.
Transport Costs and Geographical Location.
Dynamic Economies of Scale (2+ versions of product).
Mismeasurement due to degree of product aggregation.
Differing Income Distributions within Countries.
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Intra-Industry Trade
U.S. Imports/Exports of Auto Parts, Engines, & Bodies
(Millions of $)
Total
(All Areas)
EEC
All W.
Europe
Canada
Latin
America
U.K.
Japan
1965
193
18
50
72
113
1
7
1970
1,464
39
159
207
1,080
19
152
1975
3,235
73
325
433
2,033
207
528
1979
6,965
211
1,059
1,337
3,749
569
1,084
1965
867
18
32
71
622
116
4
1970
2,237
32
74
149
1,602
275
17
1975
4,993
56
160
314
3,521
648
35
1979
8,446
165
376
667
5,317
1,530
53
Year
Imports
Exports
Source: R.B. Cohen, Trade Policy in the 1980’s, IIE
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Types of Industry Structure –
A Review
Perfect Competition, Monopoly, and
Monopolistic Competition
Perfect Competition
“Price-taker” Markets
Price Takers & Perfect Competition
General Condition for Maximizing Profits
•
Choose level of output so that Marginal Revenue = Marginal Cost
Price-Takers:
•
Firms that take market price as given when selling their product.
Each is small relative to market, cannot affect price.
Purely Competitive (or Price-taker) Markets
•
Markets characterized by large number of small firms producing
identical products in industry with complete freedom or entry/exit.
Price-Taker Behavior to Maximize Profits
•
•
•
Marginal Revenue of each unit of output sold = Market Price.
Price-taking firm sets output so Marginal Cost of last unit of output
produced equals market price.
In LR equilibrium, firms earn zero economic profits as entry or exit
occurs.
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SR Equilibrium: Price-Taker Market
Price, p
MC = SR Supply above PMin
ATC
AVC
p1
p2
p1
SR Profits
pLR = MRLR
SR Losses
p2
pmin
q2 q1
Quantity, q
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Perfect Competition & Supply Curves
SR Supply for Individual Firm = Marginal Cost curve above AVC.
SR Supply for Market = horizontal sum of all the marginal cost curves of
firms in the industry.
LR Supply for Market: shows minimum price that firms will supply any
level of market output, given sufficient time to adjust all factors of
production & allow for any entry/exit from the industry.
–
Economies of Scale determine Shape of LR Supply
•
Constant Returns to Scale (i.e. Constant cost) industry will have
horizontal LR Supply Curve.
•
Increasing Returns to Scale (i.e. Declining cost) industry will have
downward-sloping LR Supply Curve.
•
Decreasing Returns to Scale (i.e. Increasing cost) industry will have
upward-sloping LR Supply Curve.
–
LR Supply Curve is more elastic than SR Supply Curve
•
One or more factors fixed in SR, limits supply response to any change
in demand. More flexibility in LR to adjust.
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Monopolistic Competition
“Price-searcher” Markets with Low
Barriers to Entry
Price Searcher Markets with
Low Entry Barriers
Competitive Price-Searcher Markets (Monopolistic Competition)
•
Each firm faces a downward-sloping demand curve for their output.
•
•
Firms produce differentiated products. Output of other firms close
substitutes, so individual firm’s demand curve is highly elastic.
Low entry barriers allow entry or exit of firms if existing firms earn
non-zero economic profits. Each firm faces competition from existing
firms in industry & potential new entrants.
Profit-maximizing Behavior for a Firm in Price Searcher Market
•
•
Set output level so that Marginal Cost equal to Marginal Revenue.
Marginal Revenue is related to shape of the firm’s Demand Curve.
•
•
•
Intuition for two factors at work to sell additional unit of output.
(+) In the long run, competition along with free entry and exit will drive
prices down to level of average costs.
(-) LR equilibrium is not efficient, however, because firms produce less
than the minimum ATC level of output.
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SR Monopolistic Competition
1. Each firm has set of cost curves
Price, p
MC
pMC
2. Each firm has demand curve for
its own product. Also has MR.
3. Each firm sets output so that
MR =MC to max. profits
4. In SR, firms may have
positive or negative profits.
ATC
SR Profits
Demand
MR, Marginal Revenue
qMC
Quantity, q
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LR Monopolistic Competition
1. In SR, firm has positive profits.
Price, p
MC
2. New firms enter. Lowers each
firm’s demand & MR curves.
3. In LR, zero economic profits at
profit max. MR = MC
ATC
pLR
DSR
MRLR
qLR
MRSR
DLR
Quantity, q
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Markets with Low Entry Barriers
Competition is an important disciplinary force in a price-searcher
market where barriers to entry are low.
•
•
•
Competition places pressure on producers to operate efficiently and
cater to preferences of customers.
Competition provides firms with strong incentive to develop improved
products and discover lower-cost production methods. (entrepreneurs &
innovation)
Competition causes firms to discover the type of business structure and
size that best keep per unit costs of production low.
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Monopoly
“Price-searcher” Markets with High
Barriers to Entry
Price Searcher Markets with
High Entry Barriers
Monopoly is a market characterized by:
1.
2.
Single seller of a well-defined product with no good substitutes.
High barriers to entry of any other firms into market for the product.
Oligopoly is a market characterized by:
1.
2.
3.
4.
Small number of rival firms in industry.
Interdependence among sellers as each is large relative to market.
Substantial economies of scale in production of the good.
High barriers to entry firms into market.
Profit-maximizing Behavior for a Monopolist
•
•
Sets output level so that Marginal Cost = Marginal Revenue.
Marginal Revenue is related to shape of the Demand Curve. Intuition
for two factors at work to sell additional unit of output.
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Profit-Maximizing Monopolist
Cost, C and
Price, p
MC = Supply
pMonop
MR Curve
pComp
Demand
qMonop
qComp
Quantity, q
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Oligopoly
Oligopolists have a strong incentive to collude;
–
By colluding, i.e. acting as a cartel, oligopolists can coordinate
supply decisions to maximize the joint profits of all the firms. Cartel
seeks to create a monopoly in market.
Obstacles to collusion among oligopolistic firms;
–
Incentive for any firm to cheat on cartel agreement to increase its
profits. Obstacles to success of collusion:
1.
2.
3.
4.
5.
Increase in number of firms making up oligolpoly.
If price cuts by individual firms difficult to detect & prevent.
Low barriers to entry. Successful collusion induces new entrants.
Unstable demand conditions lower likelihood collusion successful.
Vigorous antitrust actions increase cost of collusion.
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Problems with Natural Monopoly
Cost, C and
Price, p
pMonop
pReg
ATC
MC
MR
qMonop qReg
Demand
Quantity, p
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New Approaches to Trade I
Price-Discriminating Monopolists
and Dumping
Monopoly and “Dumping”
1. Domestic Monopolist produces at MR=MC, (P0, Q0).
Cost, C and
Price, P
2. Assume can export output as price-taker at Pint =MRInt
3. Monopolist will equate MR across markets to allocate
total output so as to maximize profits.
4. Result is that PHome higher than PInt, i.e. firm is
“unfairly” dumping output in foreign market.
PHome
P0
MC
PInt
DInt = MRInt
DHome
MRHome
Q0
QHome
Quantity, Q
QExports
Total Q
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Price Discriminating Monopolist
1. Assume Price-discriminating Monopolist with constant MC across markets.
2. Will determine price/quantity in each market as MC =MR1 = MR2.
3. Result will be different prices in each market depending on demand conditions.
Cost, C and
Price, P
Cost, C and
Price, P
Market 1
Market 2
P1
P2
MC
MC
D2
D1
MR2
MR1
Q1
Quantity, Q
Q2
Quantity, Q
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New Approaches to Trade II
External Economies of Scale and
Trade
Sources of External Economies
• External Economies to Scale occur at the level of
the industry, rather than the individual firm.
• Sources of External Economies
– Clustering of Specialized Suppliers.
• Localized industrial cluster of firms collectively create market
large enough to support specialized equipment or support.
– Pool for Specialized Labor.
• Localized industrial cluster collectively create & support
market for specialized labor. Benefits both labor & firms.
– Knowledge Spillovers.
• Localized industrial cluster of firms create informal exchange
of ideas and knowledge for innovation.
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External Economies & Specialization
1. Strong External Economies tend to reinforce
existing patterns of IIT regardless of initial source.
2. Developed Country (DC) initial producer of Good
at Q0 and Pw = ACDC.
3. Less Developed Country (LDC) tries to enter with
lower AC Curve. Unable to because cannot compete
when denied scale effects of prod’n (Cost = C0 > Pw).
Cost, C and
Price, P
C0
PW
ACDC
ACLDC
DWorld
Q0
Quantity, Q
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Infant Industry Argument
1. LDC may try to protect its industry from ROW
exports to gain scale effects in prod’n.
2. Prohibitive tariff or quota closes LDC market. LDC
producers face DLDC , produce to meet demand.
3. Domestic producers reach ACLDC = PLDC < Pw. Can
now undersell DC producers on world market.
Cost, C and
Price, P
C0
PW
PLDC
ACDC
ACLDC
DWorld
DLDC
Q0
Quantity, Q
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Dynamic Scale Economies
1. Strong Dynamic Learning effects reinforce
existing patterns of IIT.
2. Learning Curves, LC, reflect cost saving
from cumulative output learning effects.
3. Again, if DC is first in industry, cost savings
from learning will dominate lower LCLDC.
Cost, C and
Price, P
C0
PW
LCDC
LCLDC
DWorld
Q0
Quantity, Q
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New Approaches to Trade III
IRS, Imperfect Competition and
Intra-Industry Trade
Imperfect Competition
• Pure Monopoly:
– Firm faces no competition, faces downward-sloping Demand Curve.
– Maximizes profit by setting Quantity to ensure:
Marginal Revenue = MR = MC = Marginal Cost
• Monopolistic Competition:
– A-1: Each firm differentiates its product from that of rival firms.
– A-2: Each firm takes rivals’ prices as given in setting own price.
– Result: Each firm acts like a monopolist in pricing (MR = MC), even
though each faces competition from many rivals.
– Special case of oligopoly:
• Market structures where firms have interdependent pricing decisions.
– Ignoring opportunities for collusive behavior between firms.
– Also ignoring opportunities for strategic behavior between firms.
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SR Monopolistic Competition
1. Fixed Costs generate IRS for each firm.
Cost, C and
Price, P
2. In SR number of firms fixed, each with
produces differentiated product.
3. Each sets MR=MC to determine output level.
4. In SR all firms earn positive economic profits.
Implies will have entry into industry.
P
ProfitSR
AC
AC
MC
MRSR
QMCSR
DSR
Quantity, Q
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LR Monopolistic Competition
1. Entry by new firms pushes down Demand
Curve for each firm to DLR.
Cost, C and
Price, P
2. Entry continues until pushes DLR tangent to AC.
3. In LR equilibrium, each firm earns zero economic
profits. More firms & more types of goods.
P=AC
AC
MC
MRSR
DSR
DLR
MRLR
QMCLR
Quantity, Q
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The Krugman Model - Details
• IRS at firm level due to fixed costs.
• Firm-level costs: C = F + cQ or AC = F/Q + c
• Firms produce differentiated goods with market structure
that of monopolistic competition.
• Firm-level Demand: Q = S[1/n – b(P-Pbar)]
• Where S = Industry sales, Pbar= Competitor’s Price, n = #firms.
• Industry-level costs (CC Curve):
– AC = F/Q + c = F/(S/n) + c = n x F/S + c
– More firms in the industry, the higher is the average cost.
• Industry-level Price (PP Curve):
– Set MR = P – Q/(S x b) = c or P = c + 1/(b x n)
– More firms in the industry, the lower the price each firm charges.
• Equilibrium:
– CC and PP Curves intersect at zero-profit # of firms in industry
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The Krugman Model - Diagram
1. Fixed Costs imply upwardsloping CC Curve.
Cost, C and
Price, P
2. Monopolistic competition implies
downward-sloping PP Curve.
CC
3. With n1 in industry, each firm
makes +ve profits, entry occurs.
AC2
P1
4. With n2 in industry, each firm
makes -ve profits, exit occurs.
5. Only at n* firms in the industry
does each firm make zero profits,
no entry or exit occurs.
P* =AC
AC1
P2
PP
n1
n*
n2
Number of Firms, n
42
Trade & the Krugman Model
Cost, C and
Price, P
CC
1. Introduction of trade increases
size of market. Result is lower CC
Curve for any given level of n.
CCTrade
2. More firms in market after
trade, i.e. greater variety of goods.
P0 =AC0
3. In addition, lower AC and so
Price for goods after trade.
P1 =AC1
PP
n0
n1
Number of Firms, n
43
Product Differentiation & Trade
• With IRS technologies, trade & gains from trade can arise
even if both economies identical. (Non-comparative
advantage trade)
• Several sources for gains from trade. Expansion of IRS
sector leads to pro-competitive gains: profit effect and
decreasing average cost effect.
• Gains from trade may be captured as increased product
diversity or lower average costs or both. Krugman model is
example of where both occur together.
• Trade based on scale economies may drive factor prices
farther apart in the two countries. Also make it more likely,
however, that all factors gain from trade.
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Summary of Scale Effects
on Trade Patterns
Empirical Summary of IRS Models
1.
2.
3.
4.
5.
Gains from IRS occur in addition to gains from comparative
advantage. Theories are thus complementary to Standard
Trade model results.
Pattern of specialization, and thus trade patterns, inherently
arbitrary. Possibly dependent on historical factors, open to
strategic interventions (first mover advantage) to capture
highest welfare effects.
IRS models offer more possibilities for gains from trade.
Empirical evidence indicates IRS important determinant of
trade flows for countries size of Canada or Western European
nations. Primarily rationalization of manufacturing.
Increased mobility of factors of prod’n (mostly capital)
suggests comparative advantage models may become
increasingly less important.
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