ECONOMICS 3150B Lecture 13 November 3, 2005

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ECONOMICS 3150BLecture 13November 3, 2005
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Test on Tuesday, November 8 _at_ 1255-220PM
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Responsible for Test 2Part 1 Currency
Markets, Exchange rates, Currency markets, Fixed
vs. flexible exchange rates, Common currency
areaPart 2 Classic Trade TheoryReadings chs.
1-5, 7, 12-15, 17-21
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External Economies of Scale

• Small country-large country model
• Assumptions
• Two countries A (small country) B (large
  country)
• Two factors of production
• Two products
• Same tastes
• Same production technologies
• Same relative availabilities
• Y1 external economies of scale
• Y2 constant returns to scale

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External Economies of Scale

• ?i unit cost (AC) for product i
• ?1A gt ?1B
• ?2A ?2B
• Perfect competition P AC (zero economic
  profits)
• Pi ?i ? P1/P2A gt P1/P2B
• Country B has comparative advantage in Y1,
  country A in Y2
• Large country will produce Y1 to fully exploit
  economies of scale
• Industry 1 expands in country with initial cost
  advantage (B) and contracts in the other (A)
• Gains from trade result from expansion of
  industry with external economies of scale

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Internal Economies of Scale

• Internal economies of scale for Y1 ? imperfect
  competition
• P1 gt AC1 ?1
• No assurance that P1/P2A gt P1/P2B
• Monopolist may produce Y1 in both A and B, but
  necessarily with same technologies ? different
  degrees of economies of scale
• Competitive advantage ? How was monopoly position
  obtained?
• Oligopoly possible that more than one firm will
  produce Y1 in the large country because economies
  of scale may be exploited at well below market
  demand level (MES lt D)
• P/AC may be lower than in case of monopoly ?
  depends on degree of rivalry
• Smaller number of oligopolists in small country,
  thus P/AC margin may be greater than in large
  country
• Competitive advantage ? How did oligopolists
  arise?

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Monopolistic Competition Model

• Large number of competitors (large undefined)
  producing different, yet similar products
  (product differentiation)
• Problems
• Competitive advantage and creation and
  introduction of different varieties of product
  why does one firm produce a particular
  brand/variety?
• Defining industry boundaries
• Stability tendency for consolidation if there
  is value in brand names imperfect information
  and brand names as signal for quality
• First mover advantages distribution channels,
  brand name reputation, market pre-emption
• Linear model
• Circular model
• Full price to consumers of variety j Pj
  disutility of variety j differing from desired
  variety tabs(Zj Z)

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Monopolistic Competition Model

• Entry/exit process in circular model
• Pre-emption
• Fighting brands
• Distribution channels economies of scale,
  transactions costs
• If Y1 characterized by monopolistic competition
  and Y2 is homogeneous product with constant
  returns to scale
• Intra-industry trade
• Inter-industry trade based on comparative
  advantage
• Trade will lead to lower prices, lower unit costs
  and more varieties ? gains from trade greater
  than in standard trade model with constant
  returns to scale

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Canada-US FTA

• Argument in favour of FTA with US based on Canada
  exploiting economies of scale and gaining secure
  access to US market (required to encourage
  investment in Canada and restructuring)
• Productivity levels in Canada 25 below US
  because Canadian branch plant replica of US
• Same number of varieties and shorter production
  runs
• Less competition thus X-inefficiency and less
  incentive to innovate
• Plant economies of scale
• Standard internal economies of scale and per unit
  costs decrease with reduction in number of
  products produced in each plant

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Canada-US FTA

• Problem with argument
• If economies of scale so important why did some
  firms not specialize and drive competitors out of
  the market?
• Tariff barriers had been declining since 1947
  what if management a problem?
• Security of access limited incentives to
  restructure

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Monopolistic Competition Model

• Standard m.c. model
• Equilibrium no. of firms, economies of scale,
  production point relative to MES
• No. of firms and no. of varieties
• Who created first variety? Competitive advantage
• Effects of entry ? resulting from increase in D
• P, output, production efficiency, profits, no. of
  firms and varieties
• In industries with economies of scale, variety of
  goods and scale of production constrained by size
  of countrys market

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Monopolistic Competition Model

• Trade results from economies of scale and
  multiple varieties of product
• Trade expands size of market ? each country can
  specialize in narrow range of products
• Gains from trade lower per unit costs and prices
  (increased production per firm) less excess
  capacity more varieties thus wider range of
  choices
• More firms serving combined markets, more output
  per firm ? closer to most efficient scale of
  production, less excess capacity
• Internal economies of scale and comparative
  advantage
• What country produces what varieties?
• Intra-industry trade

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Monopolistic Competition Model

• Extension of H-O model with internal economies of
  scale and monopolistic competition
• Assumptions
• Two countries
• Two products Y1 heterogeneous product subject
  to economies of scale Y2 homogeneous product
  with constant returns to scale
• Two factors of production
• Y1 uses X1 relatively more intensively
• A has relative abundance of X1
• Outcomes
• A net exporter of Y1, net importer of Y2
• Both intra-industry (Y1) and inter-industry trade
  (Y1, Y2)
• B will produce and export some varieties of Y1,
  but be a net importer

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Monopolistic Competition Model

• Outcomes (contd)
• No income distribution effects from
  intra-industry trade
• Pattern of intra-industry trade cannot be
  predicted
• A will produce more varieties, but cannot predict
  which ones
• Adjustment costs as some producers of Y!
  disappear in both countries
• Relative importance of intra and inter-industry
  trade depends on how similar are the two
  countries the more similar the more important
  intra-industry trade
• If B larger country, no differences in relative
  availabilities of factors of production and no
  differences if factor intensity of production
• B net exporter of Y1 more firms and varieties
  pre-trade

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Intra-Industry Trade

• Intra-industry trade often takes the form of
  production of specialized, skill or
  technology-intensive components in one country
  and assembly in another country
• Nortel develops a technology manufactured by an
  EMS company, perhaps in Canada or in some other
  country (costs and productive/ technology
  capacity) then sold as part of system or network
  by Nortel