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Global Economy and Trade Policies Lecture 2 Economies of scale and imperfect competition Economies of Scale External: cost per unit depending on size of industry, but not on size of a firm within that industry

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Global Economy and Trade Policies

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Global Economy and Trade Policies

Lecture 2

Economies of scale and

imperfect competition


Economies of Scale

External: cost per unit depending on size of industry, but not on size of a firm within that industry

Internal: cost per unit depending on size of one firm, but not on the size of the industry.

In this lecture we will discuss the combination of imperfection competition and internal economies of scale


Imperfect competition

Perfect competition: many suppliers, many customers and Adam Smith’s invisible hand sets prices, not individual actors.

In situations of imperfect competition some actors are able to influence quantity and price


Monopoly: one supplier, many customers, so supplier can control the price

Oligopoly: some suppliers, many customers

Monopsony: one customer, many suppliers

Duopsony: two customers, many suppliers


Monopolistic competition

Two key assumptions:

  • Each firm is able to differentiate its product from that of rivals

  • Each firm behaves as if it were a monopolist: it sets the price of the product independently of the behaviour of other firms


Normally,

The total costs for a firm can be expressed as follows:

Fixed cost + marginal cost X the output =

F + c X Q.

The larger the firm’s output, the less is the fixed cost per unit = internal economies of scale


Monopolistic competition and internal economies of scale

1.The more firms there are in the industry, the higher its average costs (the fewer opportunities for internal economies of scale): AC = n X F/S + c

AC = average cost

n = number of firms in the industry

F = fixed cost

S = total sales in the industry

c = marginal cost


Monopolistic competition and internal economies of scale

2.The more firms there are in the industry, the more firms compete with each other (the fewer opportunities to set prices) and thus, the lower the price each firm will charge: P = c + 1/(b X n)

P = price

c = marginal cost

b = sensitivity of each firm’s market share to the price it charges

n = number of firms in the industry


Note that…

1 is a numerator here and (b X n) the denominator. Therefore, the larger b and n, the lower the price (P).


Equilibrium in a monopolistically competitive market

Cost and price P

CC (costs)

4

3

2

1

1

2

3

4

Number of firms, n

0

PP (price)


The effects of trade


Integrated fibre optic wireless broadband adaptor industry with trade:

S=now 25000 and if you take n = 112:

CC=112X(1000/25000)+200=204.48

PP=200+1/(0.002X112)=204.46. Here, the equilibrium price is lower than before trade and consumers have more choice.


Paul Krugman won the Nobel Prize in 2008, partly because he was able to demonstrate that trade need not always be the result of comparative advantages, but of imperfect competition and internal economies of scale.

http://nobelprize.org/nobel_prizes/economics/laureates/2008/index.html

http://www.nytimes.com/2010/02/15/opinion/15krugman.html?ref=opinion


Homework

Read chapter 6,

pages 110 – 131 and 136 – 143.

Make problems 1, 5, 6 and 7 on page 145


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