Naked Economics Chapter 8

Chapter 8. Firms in the Global Economy: Export Decisions, Outsourcing, and Multinational Enterprises

1. Trade need not be the result of comparative advantage. Instead, it can result from increasing returns or economies of scale, that is, from a tendency of unit costs to be lower with larger output. Economies of scale give countries an incentive to specialize and trade even in the absence of differences between countries in their resources or technology. Economies of scale can be internal (depending on the size of the firm) or external (depending on the size of the industry).

2. Economies of scale internal to firms lead to a breakdown of perfect competition; models of imperfect competition must be used instead to analyze the consequences

In monopolistic competition, an industry contains a number of firms producing differentiated products. These firms act as individual monopolist, but additional firms enter a profitable industry until monopoly profits are competed away. Equilibrium is affected by the size of the market: A large market will support a larger number of firms, each producing at a larger scale and thus a lower average cost, than a small market.

4. International trade allows for the creation of an integrated market that is larger than any one country's market. As a result, it is possible to simultaneously offer consumers a greater variety of products and lower prices. The type of trade generated by this model is intra-industry trade.

5. When firms differ in terms of their performance, economic integration generates winners and losers. The more productive (lower-cost) firms thrive and expand, while the less productive (higher-cost) firms contract. The least-productive firms are forced to exit.

6. In the presence of trade cost, markets are no longer perfectly integrated through trade. Firms can set different prices across markets. These prices reflect trade costs as well as the level of competition perceived by the firm. When there are trade costs, only a subset of more productive firms choose to export; the remaining firms serve only their domestic

During occurs when a firm sets a lower price (net of trade costs) on exports than it charges domestically. A consequence of trade costs is that firms will feel competition more intensely on export markets because the firms have smaller market shares in those export markets. This leads firms to reduce markups for their export sales relative to their domestic sales; this behavior is characterized as dumping. Dumping is viewed as an unfair trade practice, but it arises naturally in a model of monopolistic competition and trade costs where firms from both countries behave in the same way. Policies against dumping are often used to discriminate against foreign firms in a market and erect barriers to trade.

8. Some multinationals replicate their production processes in foreign facilities located near large customer bases. This is categorized as horizontal foreign direct investment (FDI). An alternative is to export to a market instead of operating a foreign affiliate in that market. The trade-off between exports and FDI involves a lower per-unit cost for FDI (no trade cost) but an additional fixed cost associated with the foreign facility. Only firms that operate at a big enough scale will choose the FDI option over