ECONOMICS 3150C Lecture 7 November 18

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ECONOMICS 3150CLecture 7November 18
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Monopolistic Competition Model

• Large number of competitors (large undefined)
  producing different, yet similar products
  (product differentiation)
• Problems
• Competitive advantage and creation and
  introduction of different varieties of product
  why does one firm produce a particular
  brand/variety?
• Defining industry boundaries
• Stability tendency for consolidation if there
  is value in brand names imperfect information
  and brand names as signal for quality
• First mover advantages distribution channels,
  brand name reputation, market pre-emption
• Linear model
• Circular model
• Full price to consumers of variety j Pj
  disutility of variety j differing from desired
  variety tabs(Zj Z)

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Monopolistic Competition Model

• Entry/exit process in circular model
• Pre-emption
• Fighting brands
• Distribution channels economies of scale,
  transactions costs
• If Y1 characterized by monopolistic competition
  and Y2 is homogeneous product with constant
  returns to scale
• Intra-industry trade
• Inter-industry trade based on comparative
  advantage
• Trade will lead to lower prices, lower unit costs
  and more varieties ? gains from trade greater
  than in standard trade model with constant
  returns to scale

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Monopolistic Competition Model

• Standard m.c. model
• Equilibrium no. of firms, economies of scale,
  production point relative to MES
• No. of firms and no. of varieties
• Who created first variety? Competitive advantage
• Effects of entry ? resulting from increase in D
• P, output, production efficiency, profits, no. of
  firms and varieties
• In industries with economies of scale, variety of
  goods and scale of production constrained by size
  of countrys market

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Monopolistic Competition Model

• Trade results from economies of scale and
  multiple varieties of product
• Trade expands size of market ? each country can
  specialize in narrow range of products/varieties
• Gains from trade lower per unit costs and prices
  (increased production per firm) less excess
  capacity more varieties thus wider range of
  choices
• More firms serving combined markets, more output
  per firm ? closer to most efficient scale of
  production, less excess capacity
• Internal economies of scale and comparative
  advantage
• What country produces what varieties?
• Intra-industry trade

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Monopolistic Competition Model

• Extension of H-O model with internal economies of
  scale and monopolistic competition
• Assumptions
• Two countries
• Two products Y1 heterogeneous product subject
  to economies of scale Y2 homogeneous product
  with constant returns to scale
• Two factors of production
• Y1 uses X1 relatively more intensively
• A has relative abundance of X1
• Outcomes
• A net exporter of Y1, net importer of Y2
• Both intra-industry (Y1) and inter-industry trade
  (Y1, Y2)
• B will produce and export some varieties of Y1,
  but be a net importer

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Monopolistic Competition Model

• Outcomes (contd)
• No income distribution effects from
  intra-industry trade
• Pattern of intra-industry trade cannot be
  predicted
• A will produce more varieties, but cannot predict
  which ones
• Adjustment costs as some producers of Y1
  disappear in both countries
• Relative importance of intra and inter-industry
  trade depends on how similar are the two
  countries the more similar the more important
  intra-industry trade
• If B larger country, no differences in relative
  availabilities of factors of production and no
  differences if factor intensity of production
• B net exporter of Y1 more firms and varieties
  pre-trade

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Brand Names

• Imperfect information
• Re. product quality/safety lemons model
  consumers believe all suppliers produce lowest
  quality and so bad drive out good suppliers
• Re. risks adverse selection (insurance markets)
  only bad risks buy insurance, good risks
  squeezed out (experience rating) credit crunch
  because of inability to quantify credit risks
  (credit risks improperly priced) magnitude of
  liabilities stemming from terrorist attack
  (following 9-11, insurance companies tried to
  terminate insurance for terrorist attacks)
• Re. quality, motivation of workers statistical
  discrimination (do not hire from among certain
  groups of job applicants)

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Brand Names

• Brand names a signal for quality quality
  difficult to measure without repeated use of
  product brand name developed over time provides
  some assurance to consumers about quality of
  product
• Developing a brand name
• Consumers willing to pay price premium for
  established brand name products
• Travel abroad, willing to purchase brands
  recognized from home (hotels, consumer goods,
  financial institutions, entertainment)
• Example of products from China

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Brand Names

• Value of brand name Apple, Armani, BMW, Canali,
  Coach, Coca Cola, Disney, Ferrari, Goldman Sachs,
  GE, Google, Harvard, HM, IBM, Ikea, McKinsey,
  Mercedes, Miele, Nike, Prada, Starbucks, Tata,
  Toyota, Trump, Virgin Group, Wynn, etc.
• Transferable to other markets? geographic,
  product

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Intra-Industry Trade

• 25 of world trade
• Most significant in sophisticated manufactured
  products (machinery, chemicals, pharmaceuticals,
  telecommunications equipment, autos, aerospace)
  and trade among industrialized countries
• Intra-industry trade often takes the form of
  production of specialized, skill or
  technology-intensive components in one country
  and assembly in another country
• Nokia develops a technology manufactured by an
  EMS company, perhaps in Canada or in some other
  country (costs and productive/technology
  capacity) then sold as part of system or network
  by Nokia

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Intra-Industry Trade

• Competitive advantage and introduction of new
  product/variety
• Caters to domestic demand (tastes, income levels)
  
• Uses familiar technology
• PLC growth in domestic demand ? entry expansion
  of demand in other markets
• Small size initially of foreign markets ? with
  economies of scale, supply foreign markets from
  domestic plants
• Growth in foreign markets ? expansion of
  production, creation of subsidiaries as
  consolidation reduces number of competitors
• Companies with foreign subsidiaries will transfer
  production more quickly

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Canada-US FTA

• Gains from trade
• Traditional comparative advantage, new products
• Larger markets economies of scale, plant
  economies (specialization), learning curves
• Increased competition new products, higher
  quality, lower prices, efficiency
• Minimize trade disputes less likely to be
  side-swiped when trading partner initiates trade
  dispute against other countries dispute
  resolution mechanism fairer and quicker in
  resolving trade disputes
• Consider softwood lumber under NAFTA, subsidies
  for regional jets
• Losses
• Income losses for owners of relatively abundant
  resources
• Adjustment to new trade patterns unemployment
  during transition

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Canada-US FTA

• Argument in favour of FTA with US based on Canada
  exploiting economies of scale and gaining secure
  access to US market (required to encourage
  investment in Canada and restructuring)
• Productivity levels in Canada 25 below US
  because Canadian branch plant replica of US
• Same number of varieties and shorter production
  runs
• Less competition thus X-inefficiency and less
  incentive to innovate
• Plant economies of scale
• Standard internal economies of scale and per unit
  costs decrease with reduction in number of
  products produced in each plant

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Canada-US FTA

• Problems with argument
• If economies of scale so important why did some
  firms not specialize and drive competitors out of
  the market?
• Tariff barriers had been declining since 1947
  what if management a problem?
• Security of access limited incentives to
  restructure

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FTA, NAFTA

• Objectives
• Eliminate barriers to trade in goods and services
• Expand liberalization of conditions for
  cross-border investments
• Dispute resolutions more binding, more
  effective enforcement
• Facilitate conditions for fair competition (labor
  and environment codes)
• Rules of origin 50 of value added (62.5 for
  autos) must originate in free trade area
• Eliminates import and export restrictions on
  energy products, no price discrimination between
  domestic and foreign consumers of energy products
• National treatment
• Trade in services subject to regulation
  (professional services) labor mobility foreign
  ownership restrictions (financial services,
  broadcasting, transportation)

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FTA, NAFTA

• Security of access not achieved trade remedy
  laws and trade disputes (S. 301 cases) dispute
  resolution enforcement mechanisms,
  effectiveness (incentives to abide by decisions)
  no list of exempt policies ? Canadian government
  policies at risk
• Ambiguous enforcement susceptible to political
  pressures ambiguous interpretation of laws
  (damage, source of damage) harassment potential
  asymmetric costs of fighting complaints
  uncertainty for customers (countervailing duties)
  
• Options for Canada
• Fight complaints in US courts and build up case
  law
• Go to WTO
• Case-by-case negotiations (example of softwood
  lumber)

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GATT

• GATT/WTO General Agreement on Tariffs and
  Trade/World Trade Organization
• 3 basic principles
• Nondiscrimination (MFN) preferential trading
  arrangements violate this principle NAFTA an
  example of preferential trading arrangement
• Elimination of quotas (except for balance of
  payments problems) international system of
  quotas in textiles, proliferation of VERs,
  exploitation of escape clause
• Consultation to solve trade disputes weak
  enforcement mechanism US domestic laws supercede
  GATT, NAFTA
• As Tariffs ?, NTMs ? because D for protection
  constant
• NTMs higher cost form of protection
• Canada essentially bystander in MTNs EU, US and
  Japan dictated outlines of agreements

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GATT

• 9 Rounds of multilateral trade negotiations
  Kennedy, Tokyo, Uruguay and Doha rounds addressed
  NTMs as first 5 focused on tariffs only
• Tokyo, Uruguay and Doha also attempted to extend
  trade rules to services and establish investment
  rules
• WTO created to replace GATT secretariat
• Responsible for enforcement of agreement and
  dispute resolution
• More formal procedures with tighter deadlines
• GATS (General Agreement on Trade in Services)
• TRIPS (Agreement on Trade-Related Aspects of
  Intellectual Property

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GATT

• Difficulties in reducing NTMs
• Definition of subsidies
• Escape clause provisions
• Dispute settlement mechanism with effective
  enforcement market power of different countries
• Trade-offs Problems in measuring concessions
• North-South issues need to develop economies
• Agriculture sector and political importance of
  farmers
• Major problem for Doha Round

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Agriculture Support

• Government support, 2007 of gross farm
  receipts
• Canada 19.4
• Australia 6.7
• Brazil 5.0
• China 8.6
• EU27 25.5
• Japan 47.5
• Russia 10.8
• S. Korea 65.1
• Mexico 13.6
• South Africa 3.3
• Turkey 18.9
• US 10.2

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GATT

• GATT includes articles on anti-dumping (Article
  6), countervail (Article 16) and escape clause
  (Article 19)
• Dumping export price below domestic market price
  (below cost of production or normal home market
  price)
• Escape clause temporary protection to limit
  imports causing serious injury to domestic
  producers
• Countervail tariffs to offset effects of
  subsidies
• Problems defining subsidies, determining
  existence of dumping, measuring degree of
  dumping, measuring injury, determining causation

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GATT and US Trade Laws

• US contingency protection legislation
  countervail, anti-dumping, escape clause and
  unfair trade (S. 301)
• First three deal with imports, unfair trade deals
  with exports as well
• US definitions of injury and causation differ
  from spirit and letter of GATT
• Unfair trade not part of GATT trade panel has
  found S. 301 to violate GATT
• Issue of sovereignty for US

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GHG Caps

• Canadas position at Bali conference on climate
  change
• All countries must agree to carbon emission
  limits, not just developed countries
• No trade advantage because of different rules
• Longer time frame to achieve significant GHG
  reduction targets

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GHG Caps

• Options
• Carbon tax
• Magnitude
• Unilateral, multilateral
• Use of proceeds
• Regulations
• Energy efficiency standards autos
• Emission limits
• Unilateral, multilateral
• Monitoring and enforcement
• Cap and trade systems
• Specific industries or general system
• Setting limits each year whose responsibility?
• Unilateral, multilateral
• Monitoring, enforcement
• Gaming of system for competitive advantage

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GHG Caps

• U.S.
• Companies reducing emissions to prevent class
  action law suits along the lines of those in the
  tobacco industry
• Lieberman-Warner Climate Security Act
• Cap U.S. carbon consumption through tradable
  permit plan
• Criticisms What level of emission reductions is
  realistic? Damage competitiveness of U.S. based
  companies without parallel commitments from
  trading partners

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Dumping

• Requirements
• Imperfect competition price setters rather than
  price takers
• Segmented markets no arbitrage
• By firms in A into B
• Price in B below price in A
• P(B) lt AC(A)
• P(B) lt AVC(A)
• Price discrimination
• Elasticity of demand differs between A and B
• Prevent arbitrage
• Warranties
• Price discrimination model
• MC(A) MR(A) MR(B)
• P(A) gt P(B)

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P1
P1(A)
P1(B)
MC(A)
D(B)
MR(B)
MR(A)
D(A)
Y1
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Dumping

• P(B) lt AVC(A)
• Beach-head strategy
• Price in short run lt price in long run
• Improved competitive position in future and
  ability to charge higher price
• P(B) lt AVC(A)
• Learning curve
• AVC in short run gt AVC in long run
• Pricing to move down learning curve and develop
  cost-based competitive advantage
• Lower price increases demand and production per
  period of time

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Dumping

• P(B) lt AVC(A)
• Objective drive competitors out of market to
  monopolize market
• How to distinguish predatory dumping from dumping
  based on competitive behaviour not aimed at
  monopolization?
• Substitute domestic competition law for
  anti-dumping provisions in trade agreements ?
  companies may be driven out of market before case
  is resolved