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Economies of Scale Economies of Scale make it advantageous for each country to specialize in the production of only limited number of goods & services and to manufacture them in large quantities, partly for exports. Two types: (1)External economiescost per unit depends on the size of industry, not the size of the firm. (2) Internal economiescost per unit depends on the size of the individual firm Internal economies and Differentiated Products (Internal economies are inconsistent with perfect competition) In monopolistic competition: (1) each firm can differentiate its product from that of its rivals. (2) each firm is assumed to take prices charged by its rivals as given. A Model of Monopolistic Competition Demand for a variety, produced by a single firm: 1 (1) Q S[ b( p p)] n Q = firm’s sales S = total sales of the industry b = responsiveness of Q to the firm’s price increase, relative to the average price changed by competitions P = Variety (firm’s product) price p = average price charged by competitors SUMMARY Demand 1 Q S [ b( p p )] n Cost F AC c Q THE MARKET POWER SCHEDULE(The PP Schedule) Q = A-BP A s sb P n P = A/B - Q/B B = sb A Q R QP Q( ) B B R A Q 1 MR ( ) ( )Q Q B B B A 2Q Q P B B B Q 1 MR P P sb bn 1 MR C P C bn MR The PP Schedule (continue) MR c Q Q P c P c sb sb s Q n 1 P c bn Markup: (The PP schedule) Pc 1 c bnc More n, smaller markup The PP-Schedule Price P 1 P c bn P Number of varieties THE INTERNAL ECONOMIES SCHEDULE (The CC Schedule) Costs TC F cQ F (2) AC c Q F = fixed costs, c = marginal cost F F (3) AC c n c Q S (4) If P P then, from (1) S (5) Q n more n Larger cost per unit Cost per unit, price CC: (AC = nF/S + c = P S given ^ P PP: (P = c + 1/bn) ^ Number of firms n MARKET EQUILIBRIUM Larger n Competition more intense Derivation of PP If each firm treats P as given S Q ( Sb P) SbP MR c n P Price ^ 1. An increase in F CC: (P = nF/S + c) 2 P2 1 ^ P 1 PP: (P = c + 1/bn) ^ Price # of firms ^ n2 n1 2 An increase in the marginal cost of production 2 1 # of firms 3. An increase in b (demand elasticity) CC 1 PP 2 PP Result: n goes up. Can get free competition free competition in the limiting case as F 0 and b perfect competition INTEGRATION OF TWO MARKETS Zero Profits due to Free Entry & Exit: ^ n = the zero profit number of firms in the industry ^ P = zero profit, profits-maximizing price Effects of MARKETS INTEGRATION - S rises, P falls. P CC1 CC2 1 P1 2 P2 PP n n1 n2 Economies of Scale, Differentiated Products and Comparative Advantage If trade is costless and technologies are similar across trading partners economies we cannot say where firms will be located in the integrated market but the market definitely will support more firms and lower prices. Two Goods: Food & Manufacturing homogenous differentiated products Constant Returns ( The Hekscher-Ohlin Model) Home (capital Abundant) Foreign (labor abundant) Inter-industry trade capital intensive good intensive in labor good Imperfect Competition Two Goods: Food & Manufacturing homogenous Home (capital abundant) Foreign (labor abundant) differentiated products Inter-industry trade Intra-industry trade capital intensive good intensive in labor good