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Imperfect Competition And Strategic Trade Policy Notes

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Is strategic policy preferable to free trade?
o Political economy model o Optimal tariff theory o Infant industry argument o Domestic problems should be solved using domestic policies o Trade wars
 Forced to keep the subsidy once introduced
 May return to pre-subsidy payoff matrix
 Waste of resources o Long term economic perspective doesn't win elections o Food is considered to be a good that all countries should be able to produce o Protectionism ALWAYS damaging

Strategic trade policy - firm has already proved itself to be 'worthy' - infant industry - not proved itself

Strategic trade policy - to defeat the competition. Import industry - to enter the competition o Import industry accepted as a temporary measure to bring an industry with a comparative advantage into the market
 in practice, not often successful

Ricardo - comparative advantage based on differences in factor productivity

H-O model - based on abundance of factors o Inter industry trade e.g. cloth and food

Krugman - new trade theories o Why do countries who have similar products trade?
 E.g. US and Japan trade cars with each other - intra industry trade

Based on economies of scale and increasing returns

Had to ignore perfect competition and constant returns to scale Krugman 1979

Advantageous to specialise as larger markets
 Reciprocal dumping

Price discrimination

Elasticities of demand and transportation costs

If foreign are more elastic, you need to sell to them at a lower price o Increase domestic price of good o Consumers prefer diversity o Firms want to win the foreign market 'International Economics' Krugman & Obstfeld (Ch 6, 7, 11)

2 reasons why countries trade: o 'countries differ either in their resources or in technology and specialise in the things they do relatively well' o 'economies of scale (or increasing returns) make it advantageous for each country to specialise in the production of only a limited range of goods and services'

'when increasing returns enter the trade picture, then, markets usually become imperfectly competitive'

'An industry when economies of scale are purely external (that is, where there are no advantages to large firms) will typically consist of many small firms and be perfectly competitive.'

'Internal economies of scale, by contrast, give large firms a cost advantage over small and lead to an imperfectly competitive market structure'

Monopolistic competition and trade: o 'In industries where there are economies of scale, both the variety of goods that a country can produce and the scale of its production are constrained by the size of the market'
 Trade increases the size of the market and hence loosens these constraints
 'As a result, trade offers an opportunity for mutual gain even when countries do not differ in their resources or technology' o The effects of increased market share:

(CC curve)

An increase in total industry sales S will reduce average costs for any given number of firms n o I.e. increase in market with constant n increases sales per firm hence reducing average cost as economies of scale

(PP curve)

The size of the market does not enter into this equation, so an increase in S does not shift this curve

Figure 6-4 pg 132
 An increase in the size of the market allows each firm, other things equal, to produce more and thus have lower AC.
 Downward shift from CC1 to CC2
 Simultaneous increase in the number of firms (and hence in the variety of goods available) and fall in the price of each. o Economies of scale and comparative advantage
 2 countries: home and foreign.

Each has 2 factors of production; capital and labour

Home has a higher capital-labour ratio than Foreign i.e. it is capital abundant

2 industries; manufactures and food o Manufactures is capital intensive industry
 'Because of economies of scale, neither country is able to produce the full range of manufactured products by itself; thus, although both countries may produce some manufactures, they will be producing different things'

If manufactures was not a differentiated product sector (perfectly competitive..) o Home would have a larger relative supply of manufactures and so would export these and import food

However, as manufactures is a monopolistically competitive sector (differentiated goods).. o Home will still be a net exporter of manufactures and an importer of food o But foreign firms in the manufactures sector will produce products different from those that Home firms produce. o Some home consumers will prefer foreign varieties so will import some manufactures as well - INTRAINDUSTRY TRADE o Remainder of trade is an exchange of manufactures for food - INTERINDUSTRY TRADE
 4 main points

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