5. Market Structure and International Trade. Consider the role of economies of scale and market structure in generating intra-industry trade.

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1 Rose-Hulman Insttute of Technology GL458, Internatonal Trade & Globalzaton / K. Chrst 5. Market Structure and Internatonal Trade Learnng Objectves 5. Market Structure and Internatonal Trade Consder the role of economes of scale and market structure n generatng ntra-ndustry trade. Become famlar wth the concept of dumpng as t pertans to nternatonal trade polcy. Readngs Paul Krugman and Maruce Obstfeld, Internatonal Economcs, Theory and Polcy, 8 th ed. (2009). chapter 6, Economes of Scale, Imperfect Competton, and Internatonal Trade. Outlne. Models of comparatve advantage, such as a basc Rcardan model or the Hecksher-Ohln model, explan nter-ndustry trade between countres wth dstnct dfferences. It has been estmated, however, that at least one-quarter of world trade s ntra-ndustry trade (n whch countres export and mport n the same sectors). Modern trade theory emphaszes economes of scale and ndustry structure. 2. A model of mperfect competton / monopolstc competton: [Note: the notaton used here s somewhat dfferent from that whch was used n class, but the model and outcomes are generally the same.] a. Basc assumptons: ) Lnear ndustry demand: P q b n 2) Indvdual frm demand: P P 3) Lnear total cost functon for frms: b. From these assumptons, notce the followng: ) Average frm cost s postvely related to n. c q c q. c q From the representatve cost functon, ATC q n and q b P P n therefore, ATC c b P P c q

2 Rose-Hulman Insttute of Technology GL458, Internatonal Trade & Globalzaton / K. Chrst 5. Market Structure and Internatonal Trade 2) Prce s negatvely related to n. ATC and 0 n From the frm-level demand functon, P P and 0 2 n b n q P b n b 3) There s an equlbrum number of frms n a market. Fgure llustrates ths outcome. As two markets are ntegrated nto one va the openng of trade, the equlbrum number of frms may rse, but may not necessarly be the smple sum of the equlbrum number of frms of the orgnal two markets. P, ATC Fgure ATCn P = ATC ( = 0) Pn n* n Furthermore, t may be shown, that the equlbrum number of frms, n*, s gven by n* b and that n equlbrum, P c. bn c. Example: Suppose there are two separate markets for automobles, and we know the followng:

3 Rose-Hulman Insttute of Technology GL458, Internatonal Trade & Globalzaton / K. Chrst 5. Market Structure and Internatonal Trade c A 900,000; q 750,000,000 5,000q B q n and 30,000,600,000 P P Gven these condtons, ntegraton of the two markets nto one market results n a reducton n the total number of frms and lower average prce: Market A Market B Integrated Market Market demand, 900,000,600,000 2,500,000 Equlbrum number of frms, n Sales per frm, q 50, , ,000 Average Prce, P 0,000 8,750 8, Importance of economes of scale / mperfect competton to our understandng of nternatonal trade: a. Allows our models of nternatonal trade to ncorporate a bt more of realty: ) Among major U.S. tradng partners, only Mexco, Chna, and OPEC countres stand out as beng sgnfcantly dfferent. 2) Among major U.S. exporters, many are domnant frms n ther ndustres, and the assumpton of perfectly compettve markets seems ncreasngly unrealstc b. Allows us to explan both nter-ndustry trade and ntra-ndustry trade. c. Patterns of trade become more unpredctable when ntra-ndustry trade s ntroduced. d. Allows us to examne the ncreasngly mportant ssue of dumpng. 4. The balance between nter-ndustry and ntra-ndustry trade flows s commonly measured by Gruebel-Lloyd ndexes, whch dsaggregate nternatonal trade by commodty groups or ndustry classfcaton and measure the degree of overlap of exports and mports wthn commodty or ndustry groups. Where X and M represent a country s exports and mports n commodty group or ndustry, a Gruebel-Lloyd ndex for a partcular perod, t, may be constructed as a weghted average of commodty or ndustry group overlap, wth weghts gven by trade n group or ndustry as a percentage of total trade: X M X M I t * X M X X M M

4 Rose-Hulman Insttute of Technology GL458, Internatonal Trade & Globalzaton / K. Chrst 5. Market Structure and Internatonal Trade Ths ndex ranges from zero when there s no overlap n commodty groups or ndustry classfcatons to one when overlap s complete. Thus, as the ndex approaches zero, a country s exportng and mportng dfferent thngs and nterndustry trade s the ncreasngly mportant form of trade n the country s overall mx of trade. Conversely, as the ndex approaches one, a country s exportng and mportng the same thngs and ntra-ndustry trade s an ncreasngly mportant element of the country s overall mx of trade. Fgures presents a pcture of an aggregate Grubel-Lloyd ndex for the Unted States from 960 to 2006: 0.70 Fgure : Index of Trade Overlap (Based on Annual Export and Import Data) Index of Trade Overlap (NBER) Index of Trade Overlap (USITC) Sources of Data: Natonal Bureau of Economc Research, World Import and Export Values, , (NBER); U.S. Internatonal Trade Commsson Dataweb, (USITC). 5. Dumpng s defned as sellng a product n a foregn country at a prce that s lower than the prce charged by the same frm n ts home market (nternatonal prce dscrmnaton) or at a low prce, perhaps even below costs of producton, n an attempt to drve compettors out of a market ( predatory dumpng). U.S. law defnes dumpng as sales whch occur at less than far value (LTFV). There are both economc and legal aspects to dumpng. a. Economc aspects ) Internatonal prce dscrmnaton Sellng a product n a foregn country at a prce that s lower than the prce charged by the same frm n ts home market. Ths can only arse n mperfectly compettve markets, where sellers face dstnct markets wth dfferent prce elastctes of demand. Fgure 2 llustrates nternatonal prce dscrmnaton.

5 Rose-Hulman Insttute of Technology GL458, Internatonal Trade & Globalzaton / K. Chrst 5. Market Structure and Internatonal Trade Fgure 2 P P DOM P FOR MC D FOR MR FOR 0 MR DOM D DOM DOM FOR If TOTAL DOM FOR, then DOM PFOR P. Ths follows from MC P. A reasonable conjecture seems to be that frms sometmes consder themselves to be n a more compettve envronment n foregn markets than n ther home markets, partcularly when they are frst enterng the foregn market. Notce that ths nterpretaton requres mperfectly compettve markets (frms possessng some degree of monopoly power), and mperfectly ntegrated markets (segmented nternatonal markets and lmted nternatonal arbtrage). The second of these condtons s met when there are transportaton costs. 2) Predatory dumpng Sellng a product n a foregn country at a prce that s below producton costs. Such a practce s necessarly strategc n character. 3) Sporadc dumpng Sellng a product n a foregn country at a prce that s lower than the prce charged by the same frm n ts home market or that s below producton costs n order to offset cyclcal downturns n the domestc market whch mght otherwse necesstate prce or workforce reductons. Such a practce s also strategc n character, but not predatory n ntent.

6 Rose-Hulman Insttute of Technology GL458, Internatonal Trade & Globalzaton / K. Chrst 5. Market Structure and Internatonal Trade b. Legal Aspects (U.S. trade law) ) Far value rules and antdumpng legslaton. Under certan crcumstances, a specal tarff may be mposed on foregn goods when a determnaton s made that the goods are beng sold at less than far value (LTFV). In addton to showng sales at LTFV, U.S. law requres that n order to qualfy for such antdumpng tarffs, t s necessary to show that the dumpng has materally njured a domestc ndustry or threatens to njure a domestc ndustry. Determnaton of far value usually entals comparson to prces for dentcal goods n the exporter s home market, or n thrd-country markets. Alternatvely, average domestc costs of producton are used, to whch s added 0% for general expenses and at least 8% for profts. 2) Antdumpng cases and the U.S. Internatonal Trade Commsson (USITC). Antdumpng cases begn wth a petton to the U.S. Department of Commerce and the USITC. The ITC s an ndependent, quas-judcal agency, headed by fve commssoners, who are apponted by the presdent, and staffed by economsts and trade lawyers. The ITC consders the followng areas when determned the presence of materal njury: Sales, market share, profts Productvty Return on nvestment Capacty utlzaton and nventores Employment and wages 3) Countervalng dutes When dumpng s determned to be attrbutable to foregn government export subsdes, the antdumpng tarff s called a countervalng duty. 6. External economes of scale and nternatonal trade. a. Specalzed supplers, knowledge spllovers, and ndustry clusters b. Dynamc ncreasng returns

7 Rose-Hulman Insttute of Technology GL458, Internatonal Trade & Globalzaton / K. Chrst 5. Market Structure and Internatonal Trade Dscusson uestons Assgnment 5 Krugman and Obstfeld, (8 th ed.), pages 50 5: 6, 7, 8, Problems Krugman and Obstfeld, (8 th ed.), pages 50 5: 4, 5. Suppose that the fgure below represents the demand and cost functons facng a Brazlan Steel frm that possesses sgnfcant market (monopoly) power. P MC D FOREIGN MR DOMESTIC D DOMESTIC a. If t were unable to export, what quantty would t sell n ts domestc market and at what prce? Suppose nstead that ths frm can export as much as t lkes of ts steel at the world prce and that t can practce nternatonal prce dscrmnaton. b. How much steel would the frm sell domestcally, and at what prce? c. How much steel would the frm export, and at what prce?