International Business Environment
CHAPTER 6
Intenal scale economies
- the result of the individual firm itself results into this
1) up-front fixed development costs is spread over the larger number of goods
2) There can be advantages of using large, specialized capital equipment that operates
at high volume but only if the productions demands are high enough for the to be
returns on this investment
3) tanks, vats and pipes are a sources of scale economies in producing chemicals
Monopolistic competitions
- a type of market structure with a large number of firms competing vigurously with each
other in producing and selling varieties of the basic product
Oligopoly
- few large firms dominate the global industry, perhaps because of substantials scale
economies
- They can control or influence prices
- Key issue: how actively these large firms compete with each other
- If they do not compete too aggressively, then it is possible for the firms to earn
economic profit, profit greater than the normal return to invested capital
External Scale Economies
- based on the size of an entire industry within a specific geographic area
- The average cost of the typical firm producing the product in this area declines as the
output of the industry ( all the local firms producing this product) within the area is
larger
- This explains clustering of the production of some products in specific geographic
areas
1) Arise if concentration of an industry’s firms in a geographic area attracts greater local
supplies of specialized services for the industry or larger pools of specialized kinds of
labor required by the industry.
2) New knowledge about product and production technology diffuses quickly among
firms in the area, through direct contacts among the firms or as skilled workers
transfer from firm to firm.
Intra- Industry Trade (IIT)
- two-way trade in which a country both exports and imports the same or very similar
products (products varieties that are such close substitutes that they are classified
withing the same industry)
Intern-Industry Trade
- a country exports some products in trade for imports of other, quite different products
Net trade
- the difference between exports and imports of that product
- Shows the product’s importance in the country’s inter-industry trade, in which some
products are (net) exported and other products are (net) imported
- Net Trade is a positive value if the country is a net exporter of the product
,IIT= (X+M)-|X-M|
X= the value of exports of the product
M= the value of imports of the product
Measure of relative importance of intra-industry trade as a share of totoals trade in the
product:
IIT share= IIT/Total trade = (X+M) - |X-M| / (X+M) = 1 - |X-M|/ (X+M)
How important is Intra- Industry Trade?
- it is more important for trade in manufactured products than for agricultural products
and other primary products
- The producrs with more total trade receive more weight in the overall average
- IIT is more prevalent where trade barriers and transports costs are low, as withing
preferential-trade areas like EU.
What explains Intra-Industry Trade?
- reflects trade driven by comparative advantage
- IIT measured over a year may reflect seasonal comparative advantages
- Product differentiation: consumers view the varieties of a product offered by
different firms in an industry as close but not perfect substitutes for each other
- This can be a very solid basis for trade
- There might not be any relative cost differents of the type emphasized by
theories of comparative advantage but there will still be international trade
- Customization, however, is limited, since we still need some internal scale
economy, so that there is cost advantage to producing larger amounts of a
specific variant
Monopolistic Competition & Trade
- Product differentiation is a deviation from the assumption of a homogenous product,
one of the standard assumptions used in the analysis of perfect competition.
1. Each of a number of firms produces a variant that consumers view as unique, so
the product offering of each firm is differentiated from the product offerings of
other firms. —> Consumers’ perceptions of differences may be based on
branding, physical characteristics, quality, effectiveness, or anything else that
matters to the consumer.
2. There are some internal scale economies in producing a product variant.
3. There is easy entry and exit of firms in the long run (and the long run arrives rather
quickly)
—> the typical firm in a perfectly competitive market earns zero economic profit (a
normal rate of return on invested capital) for the same reason (easy entry and exit) that the
typical firm in a perfectly competitive market earns zero economic prodit in long-run
equilibrium
The Market with No Trade
- as there are more models, each firm loses some pricing power as the market becomes
more rivalrous
- The price that the typical firm can charge for its model decreases as the number of
models available in the market increases.
,- Zero economic profit means that price equals unit (or average) cost.
Opening to Free Trade
-essentially with free trade, the world becomes one market
Basis for Trade
- for exporting: the domestic production of unique models demanded by consumers in
foreign markets
- For importing: the demand by some domestic consumers for unique models produced
by foreign firms
- Intra- industry trade: differentiated products can be large, even between countries that
are similar in their general production capabilities
—> scale economies play a supporting role, by encouraging production specialization for
different models. Firms in each country produce only a limited number of varieties of the
basic product
—> net trade in a product can be the result of differences in international marketing
capabilities
- can also reflect shifting consumer tastes, given the history of choices of which specific
varieties are produced by each country.
Gains from Trade
- the increase in the number of varieties of products that become available to
consumers through imports, when the country opens to trade
1. The opening (expansion) of trade has little impact on the domestic distribution of
factor income if the (additional) trade is intra-industry.
- with the expansion of intra-industry trade, all groups can gain from the additional trade
because of gains from additional product variety
2. Gains from greater variety can offset any losses in factor income resulting from
interindustry shifts in production that do occur
- with no trade, firms with different cost levels can co-exist , with lower-cost firms having
lower prices and larger market shares.
- When the country opens to trade in this type of product, the increased global
competition causes the demand curve facing a typical firm to become flatter and the
typical price declines
- Opening to trade favors the survival and expansion of firms with lower cost levels (or
higher levels of product quality)
For comparative advantage trade (Ricardian or Heckscher–Ohlin), the
restructuring is across different industries. For monopolistic competition trade,
the restructuring is across firms of differing capabilities within the industry.
, Oligopoly & Trade
Substantial Scale Economies
- an explanation for why a few large firms come to dominate some industries
- If substantial scale economies exist over a large range of output, then production of a
product tends to be concentrated in a few large facilities in a few countries, to take full
advantage of the cost-reducing benefits of the scale economies.
Even if a location initially was consistent with comparative advantage, cost conditions
can change over time. Yet, the previously established pattern of production and trade
can persist even if other countries could produce more cheaply. To see why, start with
the fact that the established locations are already producing at large scale and have
fairly low costs because they are achieving scale economies. Now consider the potential
new location. The shifting comparative advantage can provide the new loca- tion with
lower cost based on factor prices and factor availability, but that source of cost
advantage may not be enough. To be competitive on costs with the established
locations, the production level at this new location would also have to be large enough
to gain the cost benefits of most of the scale economies. This may not be possible
without an extended period of losses because (1) the increase in quantity supplied
would lower prices by a large amount or (2) established firms in other locations may
fight the entrant using (proactive) price cuts or other competitive weapons. With the
risk of substantial losses, production in this potentially lower-cost location may fail to
develop.
Oligopoly pricing
- playing the game will result in lowering profits for both companies
- Prisoners’ dilemma
- Tacit or implicit cooperation, cartels are illegal
- Both firms still have the incentive to cheat even if they cooperate by lowering price
- If oligopoly firms restrain from competition they can earn large economic profits on their
export sales
1. The high export prices enhance the exporting country’s terms of trade
2. The high profits add to the exporting country’s national incomeby capturing some of
what would have been the consumer surplus of foreign buyers
CHAPTER 6
Intenal scale economies
- the result of the individual firm itself results into this
1) up-front fixed development costs is spread over the larger number of goods
2) There can be advantages of using large, specialized capital equipment that operates
at high volume but only if the productions demands are high enough for the to be
returns on this investment
3) tanks, vats and pipes are a sources of scale economies in producing chemicals
Monopolistic competitions
- a type of market structure with a large number of firms competing vigurously with each
other in producing and selling varieties of the basic product
Oligopoly
- few large firms dominate the global industry, perhaps because of substantials scale
economies
- They can control or influence prices
- Key issue: how actively these large firms compete with each other
- If they do not compete too aggressively, then it is possible for the firms to earn
economic profit, profit greater than the normal return to invested capital
External Scale Economies
- based on the size of an entire industry within a specific geographic area
- The average cost of the typical firm producing the product in this area declines as the
output of the industry ( all the local firms producing this product) within the area is
larger
- This explains clustering of the production of some products in specific geographic
areas
1) Arise if concentration of an industry’s firms in a geographic area attracts greater local
supplies of specialized services for the industry or larger pools of specialized kinds of
labor required by the industry.
2) New knowledge about product and production technology diffuses quickly among
firms in the area, through direct contacts among the firms or as skilled workers
transfer from firm to firm.
Intra- Industry Trade (IIT)
- two-way trade in which a country both exports and imports the same or very similar
products (products varieties that are such close substitutes that they are classified
withing the same industry)
Intern-Industry Trade
- a country exports some products in trade for imports of other, quite different products
Net trade
- the difference between exports and imports of that product
- Shows the product’s importance in the country’s inter-industry trade, in which some
products are (net) exported and other products are (net) imported
- Net Trade is a positive value if the country is a net exporter of the product
,IIT= (X+M)-|X-M|
X= the value of exports of the product
M= the value of imports of the product
Measure of relative importance of intra-industry trade as a share of totoals trade in the
product:
IIT share= IIT/Total trade = (X+M) - |X-M| / (X+M) = 1 - |X-M|/ (X+M)
How important is Intra- Industry Trade?
- it is more important for trade in manufactured products than for agricultural products
and other primary products
- The producrs with more total trade receive more weight in the overall average
- IIT is more prevalent where trade barriers and transports costs are low, as withing
preferential-trade areas like EU.
What explains Intra-Industry Trade?
- reflects trade driven by comparative advantage
- IIT measured over a year may reflect seasonal comparative advantages
- Product differentiation: consumers view the varieties of a product offered by
different firms in an industry as close but not perfect substitutes for each other
- This can be a very solid basis for trade
- There might not be any relative cost differents of the type emphasized by
theories of comparative advantage but there will still be international trade
- Customization, however, is limited, since we still need some internal scale
economy, so that there is cost advantage to producing larger amounts of a
specific variant
Monopolistic Competition & Trade
- Product differentiation is a deviation from the assumption of a homogenous product,
one of the standard assumptions used in the analysis of perfect competition.
1. Each of a number of firms produces a variant that consumers view as unique, so
the product offering of each firm is differentiated from the product offerings of
other firms. —> Consumers’ perceptions of differences may be based on
branding, physical characteristics, quality, effectiveness, or anything else that
matters to the consumer.
2. There are some internal scale economies in producing a product variant.
3. There is easy entry and exit of firms in the long run (and the long run arrives rather
quickly)
—> the typical firm in a perfectly competitive market earns zero economic profit (a
normal rate of return on invested capital) for the same reason (easy entry and exit) that the
typical firm in a perfectly competitive market earns zero economic prodit in long-run
equilibrium
The Market with No Trade
- as there are more models, each firm loses some pricing power as the market becomes
more rivalrous
- The price that the typical firm can charge for its model decreases as the number of
models available in the market increases.
,- Zero economic profit means that price equals unit (or average) cost.
Opening to Free Trade
-essentially with free trade, the world becomes one market
Basis for Trade
- for exporting: the domestic production of unique models demanded by consumers in
foreign markets
- For importing: the demand by some domestic consumers for unique models produced
by foreign firms
- Intra- industry trade: differentiated products can be large, even between countries that
are similar in their general production capabilities
—> scale economies play a supporting role, by encouraging production specialization for
different models. Firms in each country produce only a limited number of varieties of the
basic product
—> net trade in a product can be the result of differences in international marketing
capabilities
- can also reflect shifting consumer tastes, given the history of choices of which specific
varieties are produced by each country.
Gains from Trade
- the increase in the number of varieties of products that become available to
consumers through imports, when the country opens to trade
1. The opening (expansion) of trade has little impact on the domestic distribution of
factor income if the (additional) trade is intra-industry.
- with the expansion of intra-industry trade, all groups can gain from the additional trade
because of gains from additional product variety
2. Gains from greater variety can offset any losses in factor income resulting from
interindustry shifts in production that do occur
- with no trade, firms with different cost levels can co-exist , with lower-cost firms having
lower prices and larger market shares.
- When the country opens to trade in this type of product, the increased global
competition causes the demand curve facing a typical firm to become flatter and the
typical price declines
- Opening to trade favors the survival and expansion of firms with lower cost levels (or
higher levels of product quality)
For comparative advantage trade (Ricardian or Heckscher–Ohlin), the
restructuring is across different industries. For monopolistic competition trade,
the restructuring is across firms of differing capabilities within the industry.
, Oligopoly & Trade
Substantial Scale Economies
- an explanation for why a few large firms come to dominate some industries
- If substantial scale economies exist over a large range of output, then production of a
product tends to be concentrated in a few large facilities in a few countries, to take full
advantage of the cost-reducing benefits of the scale economies.
Even if a location initially was consistent with comparative advantage, cost conditions
can change over time. Yet, the previously established pattern of production and trade
can persist even if other countries could produce more cheaply. To see why, start with
the fact that the established locations are already producing at large scale and have
fairly low costs because they are achieving scale economies. Now consider the potential
new location. The shifting comparative advantage can provide the new loca- tion with
lower cost based on factor prices and factor availability, but that source of cost
advantage may not be enough. To be competitive on costs with the established
locations, the production level at this new location would also have to be large enough
to gain the cost benefits of most of the scale economies. This may not be possible
without an extended period of losses because (1) the increase in quantity supplied
would lower prices by a large amount or (2) established firms in other locations may
fight the entrant using (proactive) price cuts or other competitive weapons. With the
risk of substantial losses, production in this potentially lower-cost location may fail to
develop.
Oligopoly pricing
- playing the game will result in lowering profits for both companies
- Prisoners’ dilemma
- Tacit or implicit cooperation, cartels are illegal
- Both firms still have the incentive to cheat even if they cooperate by lowering price
- If oligopoly firms restrain from competition they can earn large economic profits on their
export sales
1. The high export prices enhance the exporting country’s terms of trade
2. The high profits add to the exporting country’s national incomeby capturing some of
what would have been the consumer surplus of foreign buyers
