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Economies of scale and international trade

In the models discussed so far, differences in prices across coun-

• tries (the source of gains from trade) were attributed to differ-

ences in resources/technology. Countries specialize in the things

they do relatively well (produce inexpensively).

All these models were characterized by constant returns to scale

• technologies and perfectly competitive markets.

Not all commodity markets exhibit purely competitive behavior.

• Moreover, the phenomenon of intra-industry trade cannot be ex-

plained with models based on perfect competition.

We will therefore look at imperfect market structures, particu-

• larly at a model with monopolistic competition where there are

scale effects in production that provide an explanation for interna-

tional trade patterns going beyond the relevance of asymmetries

in technologies or factor endowments.

Two types of economies of scale

By economies of scale (EOS)we refer to the fact that the unit

• costs decrease with the scale of production. This implies the

following regarding production and pattern of trade: It pays of to

specialize in relatively few goods in order to achieve large scale of


Internal economies of scale: the size of the individual firm matters,

• i.e. larger firms have a cost advantage over smaller firms.

External economies of scale: the size of the industry matters. A

• firm trying to expand will face increasing costs, but as the industry

as a whole expands, the costs of the individual firms are lowered.

These two types of EOS have different implications for market

• structure:

– An industry with purely external EOS typically consists of

many small firms that perfectly compete with each other.

– Internal EOS, however, because large firms have cost advan-

tages over small firms, are characterized by an imperfectly

competitive market structure.

Review of the pure monopoly

Monopolistic competition

A firm making high profits normally attracts competitors. That is

• why case of pure monopoly are rather rare in practice. Oligopoly

is the market structure that is more common to industries char-

acterized by internal EOS.

Analysis of oligopolistic behavior is complex however because the

• pricing policies of the firms are interdependent. We will therefore

analyze a special case of oligopoly, i.e. monopolistic competition.

In models of monopolistic competition, two key assumptions are

• made in order to get around the problem of interdependencies:

1. Firms can differentiate their products from that of their rivals.

That is, they are not perfect substitutes but only to some

degree. This assumption assures that firms have some de-

gree of monopolistic power and are somewhat insulated from


2. Each firm takes the prices charged by its rivals as given, i.e.

it ignores the impact of its own price on the prices of other

firms: even though each firm faces competition it behaves as

if it were a monopolist.

Free entry and a downward sloping demand curve


A firm in a monopolistically competitive industry is expected:

• – to sell more the larger the total sales of the industry and the

higher the prices charged by its rivals.

– to sell less the larger the number of firms in the industry and

the higher its own price.

To incorporate these properties, we assume that a typical mo-

• nopolistically competitive firm faces a downward-sloping demand

curve of the form:

= 1/n

Q S b P P̄

× − −

The terms in the demand equations

= 1/n

Q S b P P̄

× − −

is an individual firm’s sales


• is the total sales of the industry


• is the number of firms in the industry


• is a constant term representing the responsiveness of a firm’s


• sales to its price

is the price charged by the firm itself


• is the average price charged by its competitors

Finding the market equilibrium

In order to simplify things, we assume that all firms face identical

• demand and cost functions.

In a symmetric equilibrium, the state of the industry can be de-

• scribed without going into details of each firm; all that has to be

known is the number of firms in the industry and what price a

typical firm would charge.

Once and are known, we can ask how they are affected by

n P̄

• international trade.

We follow a three step approach:

• 1. Derive the relationship between average costs and the number

of firms in a market.

2. Determine the relationship between the number of firms and

the price charged.

3. Find the equilibrium number of firms where no entry or exit





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Materiale didattico per il corso di Economia Internazionale del prof. Alireza Jay Naghavi. Trattasi di slides in lingua inglese a cura del docente, all'interno delle quali sono affrontati i seguenti argomenti: economie di scala e commercio internazionale; le tipologie di economie di scala; la concorrenza monopolistica; l'equilibrio di mercato; prodotto e flussi commerciali.

Corso di laurea: Corso di laurea in studi internazionali
Università: Bologna - Unibo
A.A.: 2011-2012

I contenuti di questa pagina costituiscono rielaborazioni personali del Publisher Atreyu di informazioni apprese con la frequenza delle lezioni di Economia internazionale e studio autonomo di eventuali libri di riferimento in preparazione dell'esame finale o della tesi. Non devono intendersi come materiale ufficiale dell'università Bologna - Unibo o del prof Naghavi Alireza Jay.

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