International Economics

Lecture 7

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 Monopoly and Trade
Markusen (1981)

• single producer of M (Monopoly market)

• many producers of F (Perfectly competitive market)
• K & L markets are perfectly competitive
• all firms max π (R0 = C0 )
• all consumers maxU, taking prices as given

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 Monopoly (graphical analysis)

Recall:
Revenues = R = p · q = (a − bq) · q = aq−bq2 ⇒ R0 = dR
dq = a−2bq

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 Monopoly
price and quantity

π = p · q − c · q = p(q)q − c(q)
Set F.O.C. for profit max:
dπ dp dc
= p+ q− =0
dq dq dq
dπ dp dc dp
= p+ q = ⇒ p + q = c0
dq dq dq dq
 
dp q dq p
p· 1+ = c0 ; and since ε(q) = −
dq p dp q
 
1
p· 1− = c0
ε(q)

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 Monopoly
price and quantity
 
1
p· 1− = c0
ε(q)
1 a−bq
if demand is linear: p = a − bq, or q = ab − b1 p; ε(q) = b q ;
 
bq
(a − bq) 1 − = c0
| {z } a − bq
p
 
a − bq − bq a − 2bq
(a − bq) = c0 ⇒ (a − bq) = c0
a − bq (a − bq)
c0 − a a − c0
a − 2bq = c0 ⇒ −q = ⇒ qmon =
2b 2b
a − c0 (a − c 0) 2a − a + c0 a + c0
pmon = a − bqmon = a − b = a− = =
2b 2 2 2
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Monopoly and General Equilibrium

c0M pM (1 − 1/εM ) pM
MRT = = < = MRS
c0F pF pF

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 Oligopoly
Duopoly

• Unique demand (we will assume a linear demand: p = a − bq)

• Total quantity is sum of Austrian and Bolivian firm
q = qA + qB
• Austrian (Bolivian) firm profits depend on Bolivian (Austrian)
firm profit
• i.e. πA = (p − c0 )qA = [(a − c0 ) − b(qA + qB )]qA
• for every choice of qB , there is a different optimal response by
A
• the combination of optimal responses of A to B output choice
is its reaction curve

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 Reaction of Austrian firm
Isoprofit curves and reaction curve (a = 8, b = c = 1)

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Cournot Equilibrium

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 Cournot profit maximisation

πA = p(q)qA − c(qA )
F.O.C.
dπA dp
= p + qA − c0 (qA ) = 0
dqA dq
dp
p+ qA = c0 (qA )
dq
dp q
p+ qA = c0 (qA )
dq q
 
d p qA q
p 1+ = c0 (qA )
dq q p
 
qA 1
p 1− = c0 (qA )
q ε(q)
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 Reaction curve

• Given linear demand: p = a − bq and cost: c0 (q) = c,

dπA a − c0 1
= 0 ⇒ qA = − qB
dqA 2b 2
and similarly for B.  
a−c0 1 a−c0 1 a−c0 1 a−c0 a−c0 qB 1 2a−2c0 −a+c0


qB = 2b − 2 qA = 2b − 2 2b − 2 qB = 2b − 4b + 4 ⇒ 1 − 4 qB = 4b ⇒
3 2a−2c0 −a+c0 0
4 qB = 4b ⇒ qB = a−c
3b = qA ;
 0
 0 0 0
pduo = a − b(qa + qb ) = a − b 2 a−c3b = 3ab−2ab+2bc
3b = ab+2bc
3b = a+2c
3

• The Curnot equilibrium is at the intersection of the two

reaction curves:
a − c0 a + 2c0 a + c0
qA = qB = ; pduo = < = pmon ; a > c0
3b 3 2

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 Duopoly vs Monopoly
• Duopoly has lower price and produces higher output than
monopoly
• more competition, measured by higher number of firms, lowers
the price level:
 
qA 1
p 1− = c0 (q),
q ε(q)
• qA is the market share of the Austrian firm. The mark up
decreases with lower market share and higher demand
elasticity.
• As N becomes large, mark-up disappears and we approach
perfect competition.
• If N=1, we go back to monopoly

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 Pro-competitive effect of international trade

1
c0M 
 pM (1 − 2ε(q) ) 
pM 
MRTduo = = < = MRSduo
c0F duo pF pF duo
Remark: Both monopoly firms in A and B have strong incentive to lobby
against international trade flows to increase their profits.

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 Reciprocal dumping
• GATT (1994): dumping as the sale of exports below “normal”
value
• Normal value:
• comparable price in the exporting country;
• comparable price for export to a third country;
• cost of production at origin plus reasonabe selling cost and
profit
• Two firms in different countries with same marginal costs, but
with “iceberg” transport costs, T c0
• Firm A, contains sales in the own market, but tries to sell in
foreign market, cause effect on lower price falls on the other
firm.
• Clearly, firm B does the same: Reciprocal dumping

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 Reciprocal dumping

• creates trade, despite initial price level is the same and there
are transport costs;
• creates trade is in the same good
• introduces competition;
• net effect is uncertain cause benefits must be matched against
resources wasted in transportation.

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 Reciprocal dumping

pA = a − b(qAA + qBA );

πA = [a − b(qAA + qBA )]qAA − c0 qAA ;

dπA
= a − 2bqAA − bqBA − c0 = 0
dqAA
⇒ −a + 2bqAA + bqBA + c0 = 0
a − c0 − bqBA
qAA =
2b

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 Reciprocal dumping

dπB
= a − bqAA − 2bqBA − T c0 = 0
dqBA
 
a − c − bqBA
⇒ a−b − 2bqBA − T c0 = 0
2b
a − c − bqBA
⇒ a− − 2bqBA − T c0 = 0
2
2a − a + c + bqBA − 4bqBA − 2T c0
⇒ = 0
2
0
⇒ a + c − 3bqBA − 2T c = 0
⇒ −a − c + 3bqBA + 2T c0 = 0
a + c − 2T c0
qBA =
3b

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 Reciprocal dumping
a + c0 − 2T c0
qBA = ;
3b
 0   
−2T c0 0 c0
a − c − b a+c 3b a − c0 − a+c −2T
3 3a − 3c0 − a − c0 + T c0 1
qAA = = =
2b 2b 3 2b
2a − 4c0 + 2T c0 1 a − 2c0 + T c0
= = ;
3 2b 3b
a − 2c0 + T c0 a + c0 − 2T c0
 
pREC = a − b +
3b 3b
0 0 3a − 2a + c + T c0
0 a + c + T c0
 
2a − c − T c
= a− = =
3 3 3

qAA > qBA ;

Austria has a higher market share, given its lower marginal cost.
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Reciprocal dumping

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 Reciprocal dumping, trade and welfare
• Symmetric nature of the model leads to reciprocal dumping
• Trade is pointless and costly, but has a pro-competitive effect, leading to
lower prices, higher quantities and smaller mark-ups
• however, welfare may still increase in both countries:
• lower price increases consumer welfare
• firm lost profits at home are partially compensated by profits abroad
• this welfare gain is uncertain and depends on the size of transport costs
• small trade costs ⇒ positive effect
• high trade costs ⇒ negative effect
• very high trade costs ⇒ no trade takes place

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