EOS Flashcards
2 assumptions in neoclassical theory
- Perfect Competition
2. Constant returns to scale implied by unit factor requirements.
In new Trade theory, gains from trade are due to….
IRS/EOS
2 assumptions in new Trade theory
- Imperfect competition
2. IRS
Internal Eos =
AC fall as output of a FIRM rises
External Eos =
AC fall as INDUSTRY output rises
Example of British industry reliant on bigger market
British car industry
Most cars produced in uk exported to eu - bigger market allows uk producers to increase output —> IRS
most inputs imported from eu
I’m perfect competition, what does the demand curve look like and why?
Perfectly ELASTIC - horizontal demand curve
Demand = MR - can sell as much as you want without lowering price
Price takers - a firm cannot influence price by changing their output.
Optimality condition for monopoly
MR=MC gives Q*
Go up to demand curve to find P*
What’s a big characteristics if imperfect competition? Why?
demand slopes DOWN and MR BELOW demand curve.
Without price discrimination, must decrease price to sell at extra unit.
But cannot discriminate so much decrease price for all existing units.
Hence MR < demand which gives price.
Profit calculation
Pi = (P - AC) x Q
Which curve shows IRS and how?
AC downwards sloping so that AC fall as Q rises
How do AC and MC relate graphically?
AC above MC due to fixed costs.
Total costs (C) =
C = F + cQ
Total costs = fixed costs + variable costs
Why do we still have IRS even with a constant MC?
Due to the fixed element of costs
Basic AC formula
AC = C/Q = F/Q + c
When do we have CRS even under imperfect competition?
If F=0 I.e. no fixed costs, AC = c
Degree of competition in monopolistic competition
NOT perfectly competitive due to PRODUCT DIFFERENTIATION
What does product differentiation mean?
Each firm produces a unique variety of the same good.
Good, but not perfect substitutes.
Small differences like branding, colour etc.
What’s the technology assumption for monopolistic competition?
SAME TECHNOLOGY - firms’ varieties only have trivial differences, but are the same quality.
Monopolistic firms behave….
AS IF they were monopolists
2 assumptions for monopolistic model
1) no strategic interaction
2) free entry
Give the general demand function Q for monopolistic
Q = S[1/n - b(P - Pbar)]
What does b measure in the demand function? (2)
b = how responsive demand is to price
Exactly PED if we take logs.
It can also measure degree of product differentiation - lower b = more inelastic = product more differentiated.
What is the important assumption about monopolistic firms?
SYMMETRIC FIRMS
- identical demand functions
- identical cost functions & production technology
But not identical due to product differentiation.
2 implications of the symmetry assumption
P = P bar - firms charge the same price in equilibrium Q = S/n - each firm produces an equal share of total industry output.
Write AC as a function of n
AC = F/Q + c
Q=S/n
—> AC = F(n/S) x c
How are AC affected by n and S?
AC = F(n/S) + c
Higher n = each firm can produce less = higher AC
higher S = each firm can produce more = lower AC
Outline steps to find the price schedule
- Find MR by dR/dQ
- Set MR=MC
- Sub in monopolistic demand function Q=S/n
Find MR
R=PQ Assume linear demand for simplicity first: Q = A - BP R = Q(A - Q / B) dR/dQ = A/B - 2Q/B A/B= P + Q/B from inverse demand —> MR = P - Q/B
Set MR = MC and sub in monopolistic demand to get final price schedule formula in terms of n.
P - Q/B = c
Q=S/n and B=Sb
—> P = c + 1/nb
How does price respond to change in n and b?
P= c + 1//nb
- Higher n = more competition = lower P
- Higher b = demand more price elastic = lower P
How does the price schedule in monopolistic differ to perfect competition? What is the additional term called?
Perfect competition: P=MC
Monopolistic: P=MC + 1/nb
1/nb = MARK-UP
Mark up is also known as…
Operating profit per unit
How can firms have +VE markup but zero profit?
Mark up = operating profit per unit - excludes FC
Total profit = 0 means operating profit = FC
- all operating profit is used to cover the FC
How do we find equilibrium in monopolistic model? Why is this a stable equilibrium?
We want to find the equilibrium number of firms
Where P=AC - no incentive to enter or exit market as profit = 0
P > AC —> firms incentivised to enter by profit, higher n means lower p and higher AC until equalise.
P < AC firms exit so the opposite happens.
Which imperfect competition structure is moot realistic?
Oligopoly - assumes strategic interaction which monopolistic abstracts from.
What does trade impact in the PP and CC schedules?
Trade —> increased market size so S rises.
P = c + 1/nb - No S so PP does NOT shift
AC = F(n/S) + c - S rises, Q rises, AC falls = CC shifts down.
Impact of trade on profits?
In SR: P > now lower AC —> positive profits in SR
But due to free entry and profit incentive new firms enter
Higher n = P contracts, AC expands —> P=AC @ new equilibrium
So in the LR, zero profits as in Autarky.
Impact of trade on AC, P, n and hence welfare
Lower AC
Lower P
Higher n = more variety
—> Welfare rises.
Does monopolistic model predict price equalisation? Why/why not?
NO - each firm produces a globally unique variety so prices do not equalise.
Trade is not bout price equalisation, instead increased industry size.
Why does higher variety benefit consumers?
Ideal variety - consumers like the choice mong different varieties, even if they only buy one.
Condition to achieve IRS through trade
Each firm must produce in ONE COUNTRY ONLY.
- Otherwise would have to pay FC more than once
Does monopolistic model predict where firms will produce? Why/why not?
NO - we do not know where they will produce, only that they must produce in one location only.
How does global equilibrium n compare to n and n* in Autarky? Why?
Global equilibrium n > both Autarky n and n*
But global equilibrium n < n+n*
Some firms exit - otherwise the increased market size would be exactly offset by increased n, so there would be no IRS.
Which firms will leave in the basic monopolistic model f trade?
The model does NOT predict which firms leave due to symmetry assumption.
Inter industry trade =
Neoclassical Trade
Each country specialises in the. Production of ONE GOOD.
No varieties
Export one good, import a different good = Trade between industries.
Intra industry trade =
Monopolistic Competition Trade
Both countries export their own variety of a good, and import the other country’s variety of the same good.
Hence trade occurs within industries.
In a hybrid model, how does comparative advantage still have a role for INTRA industry trade?
INTRA industry trade= each country exports own variety and imports the other variety f the same good.
—> But country with a comparative advantage in the differentiated good will be NET-EXPORTER.
Summary: the 2 independent sources of gains from trade are…
- Gains from inter industry trade reflect comparative advantage under perfect competition
- Gains from Intra industry trade reflect IRS and wider consumer choice under monopolistic competition.
Does the monopolistic model have any income inequality implications?
NO - the model only needs one FOP.
Wat does the relative importance of inter and Intra industry trade depend on?
Similarity between countries in relative amounts of FOPs.
- similar relative amounts of FOPs = lots of INTRA
- different = lots of INTER
What % of world trade is INTRA? In what industries is INTRA higher for US?
25% average across all industries
Industries will skilled labour, K, tech = lots of Intra
Labour intensive goods = lots of Inter for US
How is an industry defined? How does the relative importance of Intra and inter depend on classifications?
SITCs = standard international trade classifications
More digits = finer the classification = more INTER
- because little variety within a classification & less likely 2 countries will export the exact same good.
History and accident example in China
Buttons
- 1980, 3 brothers started picking up buttons off the street in Qiaotou in China
- 25 years later: 700 factories, 15bn buttons, 200 m meters of zips a year.
Dumping =
The practice of charging a lower price for exported goods than the same good sold domestically.
= form of price discrimination
2 conditions for price discrimination & hence dumping
- Imperfect competition- need to be a price maker
2. Segregated markets to prevent arbitrage
Why do firms practise dumping??
Profit maximising due to differences in home and foreign markets.
Greater market dominance at home = charge higher price
Demand more elastic in foreign = charge lower price.
For dumping analysis, what market structures do we assume for home and foreign?
Home = monopoly - full market power
Foreign = perfect competition - no market power
(2 extremes)
Dumping: the total output of a firm is determined by…
Perfect competition FOC: P=MC
Where P is Pfor given by perfectly elastic demand curve
Dumping: how much to sell at home and abroad out of totes output is determined by…
MRdom = MR for
Sell this amount at home, and remaining units abroad.
How does the price and quantity sold at home when dumping compare to standard monopoly?
Even higher price and even lower quantity than under standard monopoly.
Which 2 US bodies are responsible for protectionism in response to dumping?
US commerce department
International Trade commission (ITC)
The level of an Anti dumping tariff =
Tax = fair price - actual price
Where fair = the price the good is normally sold for in the firm’s domestic market.
3 supply side reasons for external EOS
- Specialise equipment and services e.g. Silicon Valley computer chip companies locate nearby = cheaper and more accessible
- Labour pooling = lower search and hiring costs
- Knowledge spillovers between workers from different companies.
1 demand side reason for external Eos
More variety for consumers in a big concentrated industry = can attract more customers together than the sum of what they could attract individually.
If external Eos exist, the pattern of trade may be due to….
History & accident
- countries start out producing in an industry due to accident, and remain due to a head start meaning large industry = lower AC by external Eos
A country is deterred from entering global market if…
Its fixed costs C0 > price charged by incumbent
This incumbent is able to charge a low price due to high output —> external EOS
Impact of trade based on external Eos on welfare
Ambiguous:
- gains from trade due to larger market size —> lower AC & P
- But barrier to entry, even for countries who may have lower AC in LR so could charge an even lower price once established.
Who produces a good subject to external Eos?
Whoever has a headstart based on history and accident
- no guarantee that the potentially most productive country will produce the good.
How could trade of a good subject to external Eos actually decrease welfare ???
If a country that is not established is deterred from entry by low AC of incumbent.
- if instead of importing, produce and sell domestically only, could have lower price due to lower AC over LR and lower demand.
Dynamic external EOS =
External Eos depend on cumulative output over time.
AC fall as cumulative output rises.
Learning effects
Graphic of dynamic external Eos =
Learning curve - shows falling AC as cumulative output rises.
What’s the infant industry argument?
Provide temporary protectionism to allow new domestic industry to grow and move along learning curve, then remove protection and able to compete globally now.
3 cons of infant industry protectionism’s
- Temporary often a long time
- Hard to identify when external Eos exist
- MORAL HAZARD - no incentive to grow and become more productive when protected —> inefficient and costly industry.
How does New New Trade theory differ from new Trade theory?
NEW = assume firms symmetric (same technology)
NEW NEW = allows for firm heterogeneity - different tech/productivity.
How do we show firm heterogeneity graphically?
Different constant MC curves
Same MR= own MC
Firms with lower MC have…
Higher Q
Lower P
Higher operating profit
For new new Trade theory, We assume firms have the same… (2)
- Demand curves
2. Level of FC
What’s the vertical and horizontal axes represent in new new profit graph?
Y axis = operating profit
X axis = MC, level of X axis = level of FC
The new new cutoff firm is where…
C* where operating profit = FC so profit = 0
The firm that is just able to cover its FC
Beyond this MC, profit < 0 —> exit
Firms with MC lower than th cutoff firm are known as…
Infra-marginal firms.
Inverse demand function for heterogenous firms
No longer assume P=P bar and Q=S/n
But use: Q=S[1/n - b(P - Pbar)]
Make P subject: P = 1/nb + Pbar - Q/sb
Slope = - 1/Sb
What inputs of inverse demand function does trade impact for new new? Hence how does the demand curve change?
.
Trade = higher n = lower intercept
Trade = higher S = flatter slope
—> demand curve pivots so that demand decreases at low Q and increases at high Q
Trade impact on productive firms
Most productive firms produce higher output so Higher demand for them.
Operating profit rises.
Impact of trade on less productive firms.
Less productive = produce lower Q initially so demand curve pivots inwards for them.
Operating profit falls or exit market if now beyond cutoff.
Impact of trade on cutoff firm and industry productivity
Cutoff tightens —> least productive firms exit
Hence average industry productivity rises.
What % US manufacturing firms export (2002)
Only 18%
% exporting firms in chemical industry
<40% firms export, even though a lot of what is produced is exported in chemicals.
Why do we only see a small % firms exporting in the data?
Trade Costs > 0 in reality
Previously model assumed zero trade costs.
Impact of trade costs on extensive and intensive margins
Extensive: fewer firms export
Intensive: out of the firms that export, lower volume of exports.
2 pieces of empirical evidence supporting adjusted models predictions on impact of trade costs
- Only subset of firms export
2. These firms are relatively larger and more productive (lower MC)
How do we show trade costs graphically?
Trade Costs —> MC shifts up
For less productive firm, if FC now > price @ Q=0 not active in foreign market, but may still be active domestically where there are no trade costs - extensive margin.
For all firms, as MC rise, Q falls - intensive margin.
