Chapter 8 continued

1
Chapter 8 continued

• some violations of H-O assumptions

2
More Chapter 8 topics

• When HO cannot predict trade flows
• demand intensity reversal
• factor intensity reversal
• no perfect competition (deserves own section)
• Monopoly trade models
• Effect of immobile capital (next class)

3
H-O predictions

• H-O states that the basis for trade is factor
  abundance, therefore countries will export goods
  that use their abundant factor intensively and
  import goods that use their scarce factor
  intensively.
• H-O also predicts that the abundant factor will
  benefit from trade and the scarce factor will
  lose.
• This doesnt always work

4
Demand intensity reversal

• The first case where this is violated is when
  countries have a strong taste for the good that
  they should be exporting.
• Given two countries
• if both countries really really prefer the good
  whose production intensively uses their abundant
  factor (relative to the other good),
• then they may import the good produced by their
  abundant factor

5
Demand intensity reversal
Country 1 is capital abundant but likes steel
Pc/Ps low in autarky
Country 2 is labour abundant but likes cloth.
Pc/Ps is high in autarky
Steel
Steel
Cloth
Cloth
with trade, Pc/Ps rises in country 1 and falls in
country 2.
6
Demand intensity reversal
Country 1 is capital abundant but likes steel
Pc/Ps low in autarky
Country 2 is labour abundant but likes cloth.
Pc/Ps is high in autarky
Steel
Steel
Cloth
Cloth
with trade, country 1 exports cloth and country 2
exports steel.
7
Factor intensity reversal

• In this case, industries are not consistent in
  their factor intensities. Let one industry
  represent gravel and the second represent
  furniture.
• Gravel is labour intensive at low wage/rental
  ratios and capital intensive at high wage/rental
  ratios, both intensities are measured relative to
  furniture.

8
Factor intensity reversal
The isoquant for gravel is very flat, showing a
great change in K/L as w/r changes. (Extreme case
is straight line)
.
Capital
KG
Gravel
.
KG
LG
Labour
LG
9
Factor intensity reversal
The isoquant for furniture is very curved,
showing that K/L doesnt change a lot when w/r
changes. (Extreme case is L-shaped isoquant).
Capital
.
KF
.
Furniture
KF
LF
LF
Labour
10
Factor intensity reversal
Gravel uses a higher K/L relative to furniture at
high w/r, Gravel uses a lower K/L relative to
furniture at low w/r
.
Capital
.
KG
KF
Gravel
.
.
Furniture
KF
KG
LF
LG
LG
LF
Labour
11
Factor intensity reversal
Gravel uses a higher K/L relative to furniture at
high w/r, Gravel uses a lower K/L relative to
furniture at low w/r
(w/r)2
.
Capital
.
KG2
KF2
Gravel
(w/r)1
.
.
Furniture
KF1
KG1
LG2
LF1
LG1
LF2
Labour
12
Factor Intensity Reversal

• When these countries trade, the capital intensive
  industry in one country can be the labour
  intensive industry in the other.
• If country 1 is labour abundant, we might expect
  it to export gravel, since at low levels of w/r,
  gravel is labour intensive.
• However,
• If country 2 is capital abundant, we might ALSO
  expect it to export gravel, since at high w/r,
  gravel is capital intensive.

13
Factor Intensity Reversal

• with factor intensity reversals, we cannot
  predict the pattern of trade.
• Therefore
• we cannot predict the effect of trade on factor
  demands in a country
• we cannot predict the effect of trade on incomes
  of factors.

14
Monopoly

• Any kind of imperfect competition can lower the
  predictive power of the H-O model.
• Monopoly is one special case that deserves its
  own analysis.
• If an industry is a monopoly, neo-classical trade
  theory predicts that trade can sometimes be
  harmful to the countries trading.

15
Monopoly

• To put it another way, if neo-classical trade
  theory is defined narrowly, as the theory based
  on perfect competition,
• then neo-classical trade theory says very
  specifically, that it does not apply to monopoly.

16
Monopoly and trade

• There are different scenarios for monopoly and
  trade
• Monopoly can be maintained within a country, but
  the monopoly can export outside the country (not
  great for country)
• Monopoly becomes open to competition when the
  country opens to trade.
• Monopoly becomes world monopoly with trade (not
  great for anyone except monopoly).

17
Monopoly and trade

• There are different scenarios for monopoly and
  trade
• Monopoly can be maintained within a country, but
  the monopoly can export outside the country (not
  great for country)
• Monopoly becomes open to competition when the
  country opens to trade.
• Monopoly becomes world monopoly with trade (not
  great for anyone except monopoly).
• Monopoly joins other country monopolies to become
  a cartel.

18
Monopoly - review

• Market condition for monopoly
• Monopoly faces a market demand curve, price falls
  as monopoly increases supply to the market.
• Monopoly marginal revenue is NOT equal to price,
  it falls as monopoly supplies more goods to
  market.
• The marginal cost curve is NOT a supply curve for
  the monopoly. There is no supply curve for a
  monopoly.

19
Monopoly - review

• Monopoly behaviour
• Quantity supplied
• monopoly chooses the quantity to supply based on
  the marginal cost (MC) and marginal revenue (MR).
  
• At MC MR, with marginal cost rising, monopoly
  will pay more to produce an extra unit of output
  than it will earn in the market from selling it.
• Monopoly therefore supplies the quantity
  determined by MRMC

20
Monopoly - review

• Monopoly behaviour
• Price charged
• Monopoly charges the highest price it can get
  away with!
• With a market demand curve the price is
  determined by the demand curve at the quantity
  supplied by the monopoly.

21
Monopoly in country
Price
MC
P0
Marginal revenue
Demand curve
Quantity
Q0
22
Monopoly - trade

• Monopoly market conditions
• If the monopoly can maintain a monopoly at home
  and trade freely on the otherwise competitive
  international market
• then it faces 2 different demand curves
• the downward sloping home demand
• a flat (MR Pint) world demand, reflecting a
  competitive world market.

23
Monopoly - trade

• Monopoly market conditions
• Monopoly marginal revenue
• with TWO markets
• home monopoly, and
• a competitive international market
• MR is downward sloping until it hits the world
  price, then it is a flat line at the world price.

24
Monopoly in country
Price
MC
P0
Marginal revenue
PInt
Demand curve
Quantity
Q0
25
Monopoly - trade

• Monopoly behaviour
• Monopoly chooses output produced based on MC MR
  (Q1)
• Monopoly separates supply into two markets
• it chooses supply in each market to maximize
  profits.
• Home market it will supply at point where MR
  home MR international (kink). (Q2)
• note, below that point, monopolist makes less
  money selling at home than it does selling
  exports
• It sells the rest on the world market (Q1 Q2)

26
Monopoly in country
Price
MC
P0
Marginal revenue
PInt
Demand curve
Quantity
Q0
Q2
Q1
27
Monopoly - trade

• Monopoly behaviour
• Price charged by monopoly
• Monopoly charges the highest price it can get
  away with in each market
• At home, it charges P2 which is determined by the
  home demand curve
• Internationally, it charges Pint which is
  determined by the international market.

28
Monopoly in country
Price
MC
P2
P0
Marginal revenue
PInt
Demand curve
Quantity
Q0
Q2
Q1
29
Monopoly - trade

• Case 2. Monopoly with open markets
• If markets are opened internally and the monopoly
  can trade freely on the world market,
• and, if
• world markets are competitive
• then
• monopoly loses monopoly power and starts to act
  like a competitive firm.

30
Monopoly - trade

• Case 3. Monopoly with international monopoly
  power
• When a countrys monopoly because an
  international monopoly,
• if it is possible, it will price discriminate
  between markets.
• (if price discrimination is not possible, then
  the monopoly will act like a single country
  monopoly its country is the world)

31
Monopoly - trade

• Price discrimination
• Price discrimination occurs when a firm sells the
  same good to different markets at different
  prices. Therefore, one market is paying a lower
  price for the same good than another market.
• Price discrimination can only occur when a
  monopoly can separate its markets.
• That is, it must be able to sell to one market
  (lower price market) and not have the buyers in
  that market resell to the higher price market.

32
Monopoly - trade

• Price discrimination
• If a monopoly can price discriminate, it will
  sell an amount and charge a price that maximizes
  the monopolists profits in each market.
• Therefore, if it can charge a higher price in one
  market than it can in another, it will.
• The higher price will be based on the elasticity
  of demand. This will be based on the slope of the
  demand curve, and the income in the country
  (height of demand curve).

33
Monopoly - trade

• Price discrimination, monopoly behaviour
• In each market, the monopoly
• determines the amount to supply based on MRMC
  (profit maximizing amount to supply)
• charges the highest price that it can (which is
  constrained by the demand curve)

34
Price discriminating monopolist with constant MC
P
P
Country I
Country II
PI
PII
MC
MC
Quantity
QII
QI
Quantity
35
Summary

• Monopoly trade models show that
• exposing monopolies to international competition
  makes them behave like firms in a competitive
  market and lowers price and increases output at
  home.
• letting monopolies export while maintaining the
  home market can raise price and lower quantity
  supplied at home.
• letting monopolies have international monopoly
  power promotes price discrimination, which will
  lead to higher prices in richer countries or in
  countries with less elastic demand as compared to
  poor countries or countries with elastic demand.