Week 6: Economies of Scale, Imperfect Competition and Trade

The Single Market Programme

mainly restricted to product and capital markets, excluding liberalization of labour markets, which remained largely the prerogative of member states.

Internalization Advantage

A good is produced in different locations by the same firm rather than by separate firms because it is more profitable to conduct transactions within a firm rather than between firms. -Technology transfer -Vertical integration

Location Advantage

A good is produced in two (or more) different countries rather than one because of: -Resources -Transport costs -Barriers of trade

Infant Industry Argument

Temporary protection of industries enables them to gain experience -But temporary is often for a long time, -it is hard to identify when external economies of scale really exist.

Monopolistic Competition: Price The more firms

The Lower the price P = c + 1/(b x n) = PP

It's possible that a country is worse off with trade than it would have been without trade: A country may be better off if

The country produces everything for its domestic market rather than pay for imports

Monopolistic Competition: AVC The more firms

The higher the average cost AC = F/Q + c = n x F/S + c = CC

Global production networks

The main actor in the decision-making process is the MNE

By concentrating production of industries with external economies

There will be gains to the world economy

When external economies of scale are important, countries can conceivably lose from trade. Why?

-2 countries are trading a good -both countries are capable of producing the good -If country 2 were to decide to not produce the good but import the good from country 1, country 2 would be worse off -it would be cheaper for country 2 to stop importing the good and start producing the good.

Economic activity is unevenly spread across space at a country level

-Core Regions -Periphery Regions

External

-Cost per unit depends on the size of the industry -An industry will typically consist of many small firms and can be perfectly competitive -Linked to economies of scale of the size of industry -small firms can produce equally efficient as larger firms, perfect competition exists

Location decision of firms is based on which Geographical concepts

-Density -Distance -Division

Economic output is spatially concentrated at a global level in

-Europe -North America -Northeast Asia

The full integration of product markets in Europe resulted in rapid growth of trade within the European Union. For many Member States, the share of intra-EU trade in total trade rose to 50-70%. This growth in trade was almost entirely intraindustry rather than interindustry. Explain the significance of intraindustry trade in the European Union (EU-15)

-Europe is similar in resources - All the member states do not have a relative abundance of a resource, such as technology, it is the same -Comparative advantage becomes less important. -Intra-Industry and economies of scale become more imporant

Modes

-Exporting -Licensing -Alliances -Greenfields Aquisitions

Assumptions of Monopolistic Competition Model

-Industry consisting of a number of firms producing differentiated products -Free entry and exit barriers

Internal

-The cost per unit depends on the size of an individual firm -The market Structure will be imperfectly competitive with large firms having a cost advantage over small. -linked to economies of scale of the firm

Multi-plant MNEs are more likely if

-Transport Costs are high -Countries are similar in size -Plant-specific fixed costs are low -Marginal Costs are similar in both countries

Single-plant options (national exporting firm or vertical MNE) are more likely if

-Transportation costs are low -Market sizes differ -Marginal Costs differ between countries

The Eastern Enlargement of the European Union caused much more debate and political resistance in the 'old' Member States than the accession of Sweden, Austria and Finland in 1995. What is the (trade-related) reason for this marked difference?

-Wages are lower in Eastern Europe, this will increase inter-industry trade. Relocation of labor intensive production in eastern europe -Wages are high in Sweden, Austria, and Finland. It will increase intra-industry trade. there will not be a relocation of labor

Domestic Increasing Returns of scale

-can lock in an initial advantage or a head start in an industry. - Can be used to justify protectionism

When Internal economies of scale exist

-large firms may be more efficient than small firms -industry may consist of a monopoly or a few large firms (imperfectly competitive)

Countries engage in international trade for 2 reasons

1. Because they differ either in their resources or in technology 2. In order to achieve scales economies or increasing returns in production

What are the two models of international trade in which economies of scale and imperfect competition play a crucial role

1. Oligopoly 2. Monopolistic Competition

The three Elements that explain the existence of a multinational (MNE)

1. Ownership Advantage 2. Location Advantage 3. Internalization Advantage

Reasons why a cluster of firms may be more efficient than an individual firm in isolation

1. Specialized Suppliers 2. Labor Market Pooling 3. Knowledge Spillovers

Huge MNE (Multinational Enterprises) level variation

1. Struggling Chrysler 2. Dominant Microsoft powerhouse 3.Collapsed Enron 4. Upcoming Tatra new comer 5. Large Dutch MNE 6. Bank-based financing in Germany

Multiple Equilibria

Agglomeration of all firms in either North or South is an equilibrium -equilibrium might be stable or unstable.

Vertical Intra Industry Trade

At different stages of processing -Fragmentation -Slicing up the value chain

Horizontal Intra industry Trade

At the same stage of processing -Trade without serious income distribution effects

External economies

Economies of Scale that occur at the level of the industry

O

Exporting

external or internal economies of scale? A number of firms doing contract research for a drug industry are concentrated in south-eastern South Carolina.

External

external or internal economies of scale? Cranbury, New Jersey, is the artificial flavour capital of the United States.

External

O+L+I

FDI/MNE

Ownership Advantage

Firm-specific capabilities, competences, or resources that give the MNE a competitive edge over domestic rivals.

Types of Intra Industry Trade

Horizontal Intra Industry Trade Vertical Intra Industry Trade

Concept of Cumulative Causation

If a location has attracted more firms than the other location, a new firm has an incentive to locate where the other firms are.

Stable Equilibrium can be non-optimal

If all firms are located in North transport costs are only € 2. If all firms are located in South, transport costs are € 4. - Thus, transport costs for the economy as a whole are minimized if all firms agglomerate in North.

Domestic Increasing Returns of scale can be used to justify protectionism by

Infant Industry Argument -But temporary is often for a long time, -it is hard to identify when external economies of scale really exist.

external or internal economies of scale? All Hondas produced in the United States come from plants in Ohio, Indiana, or Alabama.

Internal

external or internal economies of scale? All airframes for Airbus, Europe's only producer of large aircraft, are assembled in Toulouse, France.

Internal

Economies of Scale can either be

Internal External

The second basic reason why countries engage in international trade is economies of scale. Explain, why internal economies of scale lead to a breakdown of perfect competition, while external economies of scale are consistent with perfect competition.

Internal economies of scale is linked to the economies of scale of the firms. General large firms will have a competitive advantage over the small firms and beat them. leaving fewer large firms, resulting in imperfect competition External economies of scale is linked to the economies of scale of the industry. Small firms are able to produce as equally as efficient as the larger firms. Leading to perfect competition

Because trade increases the variety of goods that consumers can buy under monopolistic competition

It leads to an increases the welfare of consumers -because average costs decrease, consumers can also benefit from a decreased price.

Single European Market : Market size and scale effects

Liberalization --> De-fragmentation --> Pro-competitive effect --> Industrial restructuring --> Fewer, bigger, more efficient firms facing more effective competition from each other

O+L

Licensing

Licensing

Motive: -Factor Seeking Strategy: -Global

Alliances

Motive: -Market seeking Strategy: -Transnational FDI: -Defensive Import substituting FDI -Offensive import substituting FDI

Exporting

Motives: - Efficiency Seeking Strategies: -Multi domestic FDI: -Reorganization investments -Rationalized Investments

Dunning's OLI Model

O = ownership advantages L = location advantages I = internalization advantages

Monopolistic Competition: Demand

_ Q = S x [1/n - b x (P - P)]

Forces of economic geography facilitated

agglomeration economies

Complete Agglomeration

all manufactures are produced in a single region -, trade between regions will be of the inter-industry type (food for manufactures).

Trade based on external economies as an

ambiguous effect on national welfare

Intra industry trade occurs

if a country simultaneously imports and exports similar goods and services.

Internal Economies of Scale

imply that a firm's average cost of production DECREASES the more output it produces.

Industry sales increase with trade

lead to decreased average costs

Greenfields Aquisitions

motive: -Strategic Asset seeking FDI: -Cross-border mergers and aquisitions

Because trade increases market size

trade is predicted to decrease average cost in an industry described by monopolistic competition

Forces of economic geography reinforced

the concentration of economic activity

Monopolistic Competition Model Expect the firm to sell less when

the greater the number of firms in the industry and the higher its own price

Monopolistic Competition Model Expect the firm to sell more when

the larger the total demand for its industry's product and the higher the prices charged by its rivals

Grubel-Lloyd index

the percentage of industry import's trade that can be characterized as "intra-industry -0 =pure inter industry trade) to - 1 = pure intra industry trade

If the manufacturing industry is located in both regions

trade will also be of the intra-industry type -Besides trading manufactured goods for agricultural products, different varieties of the differentiated manufactured products will be traded between both regions.