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)
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