ERMELINDA LOPES

elopes@eeg.uminho.pt

SCHOOL OF ECONOMICS AND MANAGEMENT

UNIVERSITY OF MINHO

BRAGA – PORTUGAL

Fax: 253 676375

January, 2016

TIEBOUTIAN MARKET STRUCTURE AND COLLECTIVE DECISION PROCESS WITHIN A GLOBAL

COMPETITION POLICY

Abstract

The Pareto optimally has been supported by perfect competition as a market structure
where efficiency is sustainable, but it is imperfect competition where there are higher
increasing returns and better redistribution, through innovation and growth, promoted
by the market size. The optimal size within the Tieboutian perspective can be reached
through the decentralization of production process that increases the market
accessibility and promotes the price competition by international trade. The marginal
rate of transformation between labor and capital is stronger within imperfect
competition market, benefiting from larger markets and investment in R&D. The results
are a diminishing in management decision time (MDT) and a lower optimal market size
(M*), as we explain analytically using the theory of collective decision.

Keywords: Imperfect competition, Tieboutian management, optimal market size.

JEL: L11, L22

1. Introduction
The market efficiency is subject to the market structure and the market structure also
depends from the market size. Then, the market efficiency is correlated with the market
size. This is the main purpose of this paper. The market size differs from several
components, including power purchasing and regulation, despite the prices of products
been related with several other factors. However, the prices depend more of the market
structure than the local production due to competitive environment, even considering
price correlation as defend Phillip et al. (2012). The relative price movements can help
also the authorities, even at international level as the World Trade Organization, to
implements antitrust regulations. However, when two products are in the same market
and their relative prices maintain a stable ratio, implies that they are close substitutes
in consumption, production, or both. It is also relevant to say that, nowadays, the
transportation cost is considered as those where are, usually, a minor or a stable source
of price differences. The R&D and the economic and financial globalization also
contribute to this result.

In this paper, we emphasize the market structure and market size as main determinants
of price and quality. The perfect competition has been those where the Pareto
optimality is analyzed in order to maximize both sides of the market: production and
consumption. However, imperfect competition is the market structure where the
efficiency is stronger allowed by R&D. We consider the global market as a whole which
creates more appropriated conditions, allowing increasing returns, and then, more
possibilities to invest in R&D. Nowadays, the increasing mobility of capital and labor
offers more opportunities to be absorbed by enterprises with bigger capacity, improving
learning by doing opportunities and capital accessibility by market financing. First, we
emphasize the relationship between the market structure and the competition policies,
second, we introduce the Pareto efficiency approach in imperfect competition market
and, finally, we suggest the Tieboutian theoretical approach and the economic analysis
of the decision process, both, as original contributions to the market efficiency economic
literature.

2
2. The Market Structure, Trade and Competition
The international trade promotes not only competition between firms, but also
increases opportunities to benefits from bigger market size. These international
activities impose also international regulations. The WTO (2004) highlights several
objectives from different competition policy, namely the freedom of trade, freedom of
choice and access to markets; as well as the prevention of abuse of economic power and
achievement of economic efficiency. The market size with its increasing returns allows
also more profits and then, more investment in physical and human capital.

The international competition policy has as main proposals, the promoting of effective
measures against internationals cartels, and also the expanding current technical
cooperation and capacity-building efforts. However, at domestic level, the competitive
legislation comes, essentially, from the industrial countries, but also increases the
number of developing countries that create competition legislation.

2.1 Types of Markets and their Function

A market can be defined as a place where people buy and sell. The globalization and
innovation process are sources of a diversity of new markets, but, at first, we can define
spot markets and future markets. In the spot market the goods, currencies or securities
are available at the moment of the contract. In the futures market the things are
available in the future data at a price fixed in advance. Considering the motivations of
the currency demand, such as transactions and speculation, this last one can increases
a lot to finance the future markets. This reason can explain the recent dimension of this
market.

Nowadays, there are a lot of products and services available, but traditionally we can
say that there are three main types of market that can be defined by their function:
Commodity markets, stock markets and foreign exchange market. All of them registered
a big increasing during the last decades, mainly, between industrial countries, but also,
between industrial and developing countries. However, there is a concentration in
industrial countries that can reduce output and raising the prices in developing

3
countries. Generally speaking, allows factor mobility, improving wellbeing and
increasing the finance opportunities.

The commodities market sustains the real economy and stock and foreign exchange
markets sustain the financial and monetary economy. The foreign exchange market is
particularly important between main international currencies that are also used as
vehicle currencies. Not less important is the stock market that improves the capital
mobility, also in order to finance the enterprise in better conditions than bank finance,
particularly, those with higher dimension and sustainability.

2.2 The Market Structure and the Market Size

The market structure differs in production sector and geographically. The structural
organization of the firm can be benefitted by both. But the market structure normally is
to measure the number and size of distribution firms. Then, a larger number of firms can
increase the competition in an industry. This is true in a domestic economy, but the
integration process creates other conditions to the mobility of productions factors and
increases the market dimension which implies a challenge, particularly, to the industrial
organizations. The attention has been given less in number and size of firms and more
in market entry barriers, that is, is lower in domestic market because has same
conditions, but higher in international market. In this sense, the World Trade Report
(2004) defines two types of barriers to entry: regulatory and structural barriers, as
government policies and sunk cost, respectively.

Traditionally, the market structures differ from market to market, but tend to be
possible to identify four market structure linked to market power by supply side. First,
the perfect competition assumes that goods are homogeneous and there are many firms
with low influence on the market price, and firms can easily enter and exit the industry.
In the imperfect competition the price can be affected by producer, benefiting or not the
market equilibrium. Monopolistic competition is a market where producer can sell
products above their marginal cost, increasing the results of firms. The power of supply
side is higher in monopoly situation. This market structure means that a single producer
can fix an artificial price. When it is happen the opposite, that is only one buyer, we have
4
the monopsony. But, It is more current a market with fewer sellers that it is called
oligopoly. This market structure is sustainable in manufacturing industries due to the
economies of scale that allows a declining in the unit cost as production increase.
However, the cartel, as the situation where companies in the same industry collaborate
by coordinating prices and sharing out markets, imposes anti-trust laws.

These different market structures offer different conditions to reach the efficiency in
the allocation of scarce resources. Traditionally, it is the perfect competition where the
efficiency requires that individual buyers and sellers cannot affect the price at which
exchange takes place in a market. But the integration and globalization process offer
other opportunities, and, at first, it is necessary bigger enterprises and need to be
competitive with complete information. For this it is necessary coherence in trade,
environmental and competition policy as suggest the World Trade Report (2004).

2.3 The Competition Policy and Its Objectives

A market sustained with a good structure promotes trade and will allow higher quality
and better prices. The openness of economies also increases the attention of
international organizations related with international trade as is the case of World Trade
Organization.

The competition policy improves an economy towards the efficiency, comprising not
only antitrust policy, but also other policies with impact on market structure, business
behavior and economic performance. In this sense, trade policy is a rule to the market
success, protecting infant-industries that will allow a decline in prices as suggest
Krugman (1984). The competition policies of different countries have a number of
common elements including those on horizontal and vertical restraints, abuse of
dominant position and merger review. There is a common goal to maintaining and
encouraging competition in order to protect the interest of consumers to benefits from
freedom of trade. In this sense, the WTR (2004) emphasizes several objectives from
different competition policy:

- maintenance of the competitive process or of free competition;

5
 - freedom of trade, freedom of choice and access to markets;
- freedom of individual action;
- securing economic freedom;
- lessening the adverse effects of government intervention in the marketplace;
- prevention of abuse of economic power;
- achievement of economic efficiency.

The competitive legislation comes essentially from the industrial countries, but also
increases the number of developing countries that create competition legislation. There
are some recent studies that refer the increase in developing country welfare resulting
from the liberalization of agricultural policies in industrialized economies allowing
higher imported merchandise. This is a global benefit of the international trade
liberalization. There is an effort in international cooperation which allows harmonizing
national competition laws and practices. In last decades the degree of international
cooperation on competition policy issues increase strongly which also promotes the
international competition policy that has the following main proposals (WTR, 2012):

- promoting effective measures against internationals cartels;

- clarifying the application of core WTO principles of transparency, non-
discrimination and procedural fairness in this area;
- promoting voluntary cooperation among national competition agencies;
- expanding current technical cooperation and capacity-building efforts.

The economic and financial globalization is promoted with the intensification of

international trade whose growth, recently, tends to be more intensive with developing
countries than between industrial countries, as we can confirm with BRIC countries.
There are also technical barriers to trade (TBT) that can be used by the countries.
However, the political economy of the standardizing process promotes the international
trade supported by the WTO. The WTR (2012) emphasize this perspective with a
dimension between trade and public policies.

3. The Market Structure and the Pareto Efficiency

6
The perfect competition is the market structure more emphasized in microeconomic
theory, generally to demonstrate its optimality in either a partial equilibrium or a
general equilibrium context, that can be illustrate geometrically and also some
associated mathematics. The optimality in perfect competition assumes that with this
market structure, it is possible to produce at lower price allowing the consumers to get
higher quantity of products. The enterprise has the market free and the consumer has
goods at lower prices.

Here, we will introduce not only the individual perspective but also the social optimality
approach as a result of the total of all individuals. This collective dimension allows us the
transition from the market to social welfare perspective. Not less important is also to
consider the Tieboutian perspective that allows, applying in this analysis the public
choice approach to the international market structure. This is really new. This approach
makes sense due to the economic globalization where it is necessary to consider the
demand side but also the supply side of the production factors, mainly labor where there
is relative rigidity mobility, considering a world as a whole. In this point, first we
concentrate our attention in efficiency of the market following the perfect competition
in order to identify the Pareto optimality in partial equilibrium and general equilibrium.

3.1 The Pareto Efficiency

The idea of Pareto efficiency can be applied to several contexts. Normally, this idea
centered their attention in the reallocation of resources that can increases the utility of
one individual without decreasing the utility of any other individual, with the purpose of
improving the welfare of society. This concept of Pareto efficiency can also be applied
to market decision process or to political decision process, that is, the collective
decisions. In the market decision process, generally, the individual has more rationality
and the utility depends, specially, of their own decision; but in the politic decision
context, is the opposite, there is more irrationality and collective decision makes more
sense, and has higher utility. The economic analysis of the public sector includes these
both sides, the market and also collective decisions where we use not only the Pareto
efficiency concept, but also the equity.

7
The Pareto efficiency concept is commonly applied to perfect competition. This market
structure in those where the power of the market is higher, and then, at first, there are
lower reasons to political intervention. The price of the market imposes efficiency in use
of resources to supply side, and allows to individuals to get the maximum goods at lower
price. Then, perfect competition save also the demand side, offering the best prices to
individuals. This general theoretical approach of Pareto efficiency can be analyzed in
detail, using the partial equilibrium approach and also general equilibrium approach. In
this context, we need to maximize the consume function, and also the production
function in order to reach the Pareto efficiency in the market, that necessarily consider
both sides simultaneously.

Our goal here is to illustrate that Pareto efficiency can also be reached in other market
structure, as is the case of imperfect competition. In a globalized world the perfect
competition cannot be possible neither be better for the society as a whole. The
dimension of the market suggests a market structure with bigger enterprises in order to
support investment in innovation that allows new products and higher quality and not
only at lower prices. The society, as a whole, benefits more from this market structure,
but from the theoretical view point, until now, does not receive the deserved attention.
This is also our purpose in this paper.

3.2 The Efficiency in Perfect Competition

In perfect competition market the competitive equilibrium is a Pareto optimum. The
good is assumed to be, rival and there is freedom of entry and exit that means the profit
maximizes the output. Producer and consumer are price taker and not price maker. Price
is as low as it can be to maintain these survival conditions for the firm, which implies
efficiency, been impossible to increase the output of a good X, without decreasing
another. It is an allocation efficient, that is, efficiency in production. For an individual,
the private good maximized its efficiency in consumption if the marginal benefits
equalized the marginal cost. Both, producer and consumer, achieve the maximum level
of efficiency with good X, called as a partial equilibrium. Considering a market as a
whole, that is, the general equilibrium, the Edgeworth-Bowley model illustrates two

8
sector, and, involved two individuals (A and B), two goods (X e Y), and two inputs: capital
(K) and labor (L). The efficient input allocation, in this case, is founded when:

MRTSXkL = MRTSYKL

That is, marginal rate of technical substitution between capital and labor in the
production of good X (MRTSXkL) will be equal, to marginal rate of technical substitution
between capital and labor in the production of good Y (MRTSYKL). The efficiency requires
that both goods are at its maximum amount of production. The following point, identify
the efficiency to both individuals, and the answer is:

MRSAXY = MRSBXY

That is, marginal rate of substitution between good X and Y, for individual A (MRSAXY),
will be equal, to marginal rate of substitution between good X and Y, for individual B
(MRSBXY). Considering both inputs (K,L) and both goods (X and Y), the efficient will be
reached when the MRT = MRS, which implies:

MRSAXY = MRSBXY = MRTXY

This is the point which meets all three efficiency conditions that Edgeworth-Bowley
model illustrates. The frontier shows the maximum utility obtainable by one individual
given a level of the other, assuming that, it is not possible to make one person better off
without making someone else worse off. However, the economic growth by perfect
competition, pressure the allocation efficiency of resources and, also, the competition
between individuals, forgetting others dimension of well-being, as quality and equity.
But, the imperfect competition improves the quality by R&D, benefits from increasing
returns allowing lower prices, and also can pay more taxes increasing the government
revenues. With these public resources the government promotes the equity and has
more sources to the redistribution sustainability. We can sustain that the social welfare
function maximizes the sum of utilities of the individuals, but they are not guaranteed
by perfect competition market.

4. Efficiency in the Imperfect Competition Market

9
The efficiency in perfect competition is a result of market with several small firms but
without capacity to support an economic environment with a stronger international
competition and also larger market. The openness of the markets allows an increasing
in capacity of the big enterprise to answers the international demand, and also benefits
from the increasing mobility of the production factors, as capital and labor. By this way,
the market can produce with lower cost, and then, also sell at lower prices. Not less
important, can benefits of scale economies and also more productivity allowing support
lower cost of production. All these reasons convince us that we must consider the
imperfect competition as a way to reach higher efficiency, and also social benefits that
result from the redistribution improved by bigger enterprises. Lower prices of industrial
production allow poorer people to have access to industrial products. This is a way to
increase the redistribution between industrial economies with more productivity and
developing economies, as suggest Lopes (2013).

At global level, we can say that, social welfare can be improved by international trade
standardizing rules, institutionalized by the WTO which creates an economic
environment to develop a stronger market through the imperfect competition.

Our attention now is to emphasize how imperfect market competition can improve
economic growth, redistribution and innovation. Commonly, the innovation centers are
developed with significant investment by big enterprises, particularly, the industrial
sectors, as is the case of pharmaceutical as refer Lopes (2013). The returns can be higher
but it is necessary to invest with long run expectations, and the perfect competition
characterized with very but little enterprises, cannot do it.

4.1 The R&D Investment and Competition

Competition policy and liberalization of trade and investment policies also open tension,
mainly, when there are exacerbating distortions in market and, particularly, in labor and
financial market, and less, in goods markets. Inefficiencies cannot be attenuated
through competition law, but through a larger market that allows efficient firms with
increasing returns, using scale economies and technology, to produce at a lower cost. In
fact, smaller firms or firms operating in a small economy prior to opening up to the world
10
economy may not necessarily have access to the scale of production required to
compete in a global economy. However, not less important to consumers, a larger
market will lead to an increase in production, but if product preferences are specific to
countries, a reduction in product variety arising from openness could lead to welfare
losses.

The technological progress is a source of growth and make available more new and
shipper products, with higher quality, attenuating some welfare losses provoked by
larger market. Traditionally innovation is treated as an exogenous process or a
byproduct of investment in machinery and equipment but, Grossman and Helpman
(1993) develop an approach where innovation is outgrowth of investment in industrial
research by forward-looking, the profit-seeking agents. Not less important is to see the
international trade as a way to spread the growth process, allowing also the diffusion of
innovation from the industrial economies to developing countries.

The enlargement of the market creates better condition for all to improve growth and
also spread innovation. In this context, knowledge improves the endogenous growth
theory, contributing to explain the long-term growth path of countries due to its
characteristics as non-rival in consumption. The national and international positive
externality of knowledge reinforces its relative advantages in any investment
opportunity. In many countries, the absence of public intervention, these “goods” would
be underprovided by the market, leading to less than the social optimal levels of supply
of knowledge, as refer The World Trade Report, 2004.

Knowledge, as human capital accumulation, it is an import support of production

process. In fact, the economic growth depends on the accumulation of capital and labor
factors, but more fundamentally need improvements in productivity whose result
depends from more improvements in human capital, namely, by R&D investment that
supports the future growth of the economies. The productivity is essential to promote
the factors mobility, but also to stimulate the international trade.

The US has higher levels of innovation and also higher labor mobility which can justify
lower disparities, if we compare with EU. However, the investment in R&D registers low
values, even in industrial economies. In 2008, the US registers 2.77% of GDP; UK 1.88;

11
France 2.02; Germany 2.53 and Italy 1.18 (OECD, 2010). It is important to say that,
Finnish reaches 3.49% and Sweden reach 3.75%. Not less important to that investment
in physical and human capital, as areas of R&D, is also the firm investment in product
and process innovation as another potential source of cross-country productivity
differences, as also referred by OECD (2010).

The innovation process has synergies in capital equipment, market prices and
production factors as labor and capital cost, and others contributions that improves the
productivity: better organization, better sources of financing, diversity of destinations
of the production, etc. All of them can be improved with market size, as we emphasized
in the following point.

4.2 The Market Size and Increasing Returns

The market structure differs with the time and between products. Some sectors more
linked with natural resources and more capital intensive impose restrictions in market
size to reach a minimum demand in order to have a market that support the process of
production. However, there are other sectors whose reason it is not the viability of the
production process, but it is the product quality and the increasing returns that only are
accessible with market size. The market size can justify other market structure than
perfect competition, mainly in industrial countries, to promote international trade and
multinational enterprises that spread quality and income redistribution in a global
perspective.

The differences in the level of productivity between firms within the same industry can
be justified, specially, by technology and management practices. The foreign
multinational firms are an engine to investment of local firms in order to improve the
productivity. It is also a way to survive. In this sense, both markets can benefits, the local
market and also the international market, being the multinational enterprises the
transmission mechanism of this process that allows higher quality and also lower prices,
by the market size towards increasing returns. The competition improves the
technological process in order to get more productivity and then, enhancing

12
investments. All these dynamics is fruitful to physical capital and new Knowledge
through R&D, and also to intangible assets, such as management and organization.

A market structure with imperfect competition can gives more guaranty to this dynamic
than perfect competition. The dimension accounts to the productivity way. Not less
important is the financial restrictions of the small firms that operate within a perfect
competition market with assets constrain and therefore also credit constrains, as well
as lower incentives to investment. Aghion, et al. (2007) refer the credit constrain also as
a barrier to the entry. The perfect competition limits the capacity of enterprises to
benefits from the advantages of imperfect competition with the market size and capital
market. Bloom et al. (2011) shown that small firms have on average lower quality
management practices than larger firms, even with rewards for high performing
workers. Then, the market size and all political interventions that can improve it, as
integration process in EU and NAFTA accelerate external trade as well as tax incentives
that improve domestic demand. By this way, there is an economic atmosphere to
enlarge the benefits with a market structure close to imperfect competition. In this
context, the convergence between dimension of the market and enterprises allowing
the increasing returns also through this perspective.

Hence, larger markets within the globalization context become to operate as perfect
competition despite their imperfect competition forces. Even in this market, producer
and consumer are more price taker and less price maker. Not less important, the quality
on offer increases in market size as refer Steven and Waldfogel (2010), particularly,
when quality is produced in industries with fixed costs. However, the same it is not
happen with variety of products offered by them. The international market regulations
pay attention because quality can be reached, essentially, with fixed rather than
marginal cost, and then, undercut its rival`s prices and increase their market share, as
also refer Steven and Waldfogel (2010). Considering the industries as a whole, there are
welfare benefits of larger markets due to, not only the number of products and quality,
but also in variety, being one major benefit of trade as is stressed by Helpman and
Krugman (1987).

5. The Tieboutian Perspective and the Market Structure

13
It is commonly accepts that perfect competition is the market structure that creates
more condition to benefits both side of the market: sellers and buyers. Conversely, in
imperfect competition, the stronger power of suppliers creates more difficult for new
entrants to make profits. But, looking to the market as a whole, the imperfect
competition is the better market structure that answers to global market using the
production conditions of the perfect competition market. Not less important, has
additional advantageous in management, that using a centralized process in
management, namely, in sources of financing reaching lower cost of capital. The better
combination between them can be similar to the collective decision process, applied in
the study of public goods decisions, as we show ahead.

5.1 The Perfect Competition and Rivalry Restriction

Within imperfect competition there are few suppliers and they uses a strong negotiation
position which create a need of regulation by the authorities, namely antitrust rules.
Claude d´Aspremont et al. (2000) retains the following question: Is the main objective
of the competition policy the maintenance of competition per se or the promotion of
economic efficiency?

At first, we can argue that competition benefits the individual allowing products at lower
prices being offered by public or private agents. In general, we can say that competition
policy can be as a right which warrants protection, but the economic and social progress
imposes other components from the market. It is also necessary a mechanism for
allocating resources that promotes economic efficiency, namely by the reduction of
costs, most efficient business, the welfare of consumers, the creation of new products,
the entry of new enterprise, the development of technological progress and innovation.
There is no market structure that gives guaranty to all this requirements at the same
time. Some of them can be reached in perfect competition and others in imperfect
competition. The characteristic of the product and also the market size contribute for
better performed firms.

In fact, the perfect competition has market instruments that answer to both question
referred above: competition and economic performance, but also limits itself in

14
fundamentals areas as innovation. Without market size the quality sustained by
innovation stay back. Then, in several circumstances it is the imperfect competition
which implies the game theory, being the answer a market in a global perspective. In
this sense, the WTO can offer an adequate competition policy in industrial sectors and,
recently, also to the services sector, as we can see through the World Trade Report
(2012). This idea can be stronger if we consider Michael Porter (1980) arguments, who
defends that it is in perfect competition market that the degree of rivalry is higher.
However, adds that, the higher the degree of rivalry the more difficulty it is for existing
firms to generate high profits. In this sense, innovation, which improves lower prices
and also higher quality, cannot be reached in this market structure. It is the imperfect
competition market that makes it possible, using the Tieboutian market perspective,
that is, a global market to sell within the similar conditions of perfect competition to
buyers, and also, at the same time, with the advantageous of increase returns to sellers.
In this case, the management of the firms must occur within an imperfect competition,
but the production process, by the supply side, and the market access, by the demand
side, must be operated, in practice, as perfect competition allowing higher efficiency in
market, in order to reach the Pareto optimality.

5.2 The Tieboutian Perspective and the Market Efficiency

In a global market the local production and management cannot be the answer to the
market efficiency, even under the perfect competition conditions. The market size
opportunities also impose not only other redefinition of the market structure, but also
another organizational concept. The capital mobility more than labor mobility
contributes to these economic and financial challenges, namely new sources of capital
offered by the market based financing, and not only by the bank based (commercial
banks). There are more welfare benefits when the market structure is made more
competitive through the removal barriers and investment restrictions, as defend Atje
and Hufbauer (1996). When trade and investment liberalization exerts an impact on
market structure it makes markets more competitive with efficiency gains. Both sides of
the market won: The supply side and demand side, but also the government. The State
as main economic agent can retain more taxes by increasing dimension of the market,

15
promoted by the international investment and trade. In this sense, the Tieboutian
perspective, that emphasize the role of the decentralization to increase the accessibility
of the individuals to the market of the public services, can also be applied here, in order
to benefits from an efficient global market structure. First, we have domestic economies
without competition policy, but with perfect competition (with lower market size) to
private goods and a monopolistic market to the public goods. Nowadays, we have
integrated and global economies with a global competition policy, but the imperfect
competition is the natural answer of this market size, requiring also some antitrust
policies, namely by WTO. Within global market as a whole, there are conditions for a big
number of firms which allow us to assume all of them as perfect competition market, as
we can see by maximization of production function, by supply side as shows the
following equation: Max π = Pi f (Li, Ki) – w Li – k Ki; where, K and L are, capital and labor,
respectively, and w e k, are unity cost, respectively. To maximize, it is necessary to get
these both equations, equalizing to zero each equation related with each factor:

δπ Pi δf - w = 0 => RMg = CMg to L

δLi δLi

δπ Pi δf - k = 0 => RMg = CMg to K

δKi δKi

Then, the cost of production to factor K relatively to factor L is equals to relative cost of
factors w e k, (w/k), that is, the relative cost of each factor depends of the respective
production functions, which implies:

δf δf

δLi δKi

= w/k < = > The marginal productivity of labor (L) relatively the marginal
productivity of capital (K), that result the MRST (i ), that is, the Marginal R of
Substitution of transformation, to good i: MRST kL (i).

Generalizing, the relative prices of production factors will be the same to any other
industry j, which implies that in perfect competition: marginal rate of substitution in
transformation of factor i, is equal to factor j. The equation is: MRSTKL (i) = MRSTKL (j).

16
The maximization of utility depends of maximization of production capacity that is

offered in market, but also considers the wellbeing, that depends of income available
and the price of each good.

The maximization of those equations implies the similar steps to the maximization of
production function: Max Z = µi (Xi, Yi) + λ ( Mi - PxXi – PyYi ).

δZ = δµi – λ Px = 0

δXi δXi

δZ = δµi – λ Py = 0

δYi δYi

δZ = Mi – Px Xi – Py Yi = 0

δλ

The utility also depends of the price of each good. The consumption good X increases
the utility and its higher price reduces its utility. The same happens with consumption
of good Y. The final result will be the following equation:

δµi

δXi Px

δµi Py

δYi

The total utility depends of the relative utility and also of its relative price. We can reach
the Pareto efficiency in production and in consumption. With these both sides of the
market we must refer the general equilibrium and then, the economic efficiency as a
whole. Generalizing from two consumers, A and B, to n consumers and Z producers, we
have de following equation: MRSYx = MRSYx (1) = ….= MRSYx ; assuming that it is not
possible, to increase the wellbeing of one person without making someone else worse.

5.3 The Optimal Market Size and Tieboutian Decision Process

The imperfect competition market is characterized by the power in market, by supply
side. There are few enterprises that control the production process, and then, the

17
consumer are price taker and the producers are price maker. There is disequilibrium
between both sides of the market. This is disadvantageous. However, in a context of big
markets, there are more firms within the market and the conditions stay close to the
perfect competition. Additionally, the firms have more exposition to international rules,
namely, by WTO. The openness of the markets needs bigger enterprises and then, they
have opportunity to benefits from increasing returns allowing better investment in
physical capital, but also in human capital. We must emphasize that imperfect
competition is the better market structure that answers to new global conditions of the
market that, considering the market as a whole, the market conditions create a perfect
competition market. Not less important, has additional advantageous in financial
management using other sources of financing, that allow lower cost of capital, and the
management of production process can be centralized in services and decentralized in
production function by two reasons: close to lower labor cost and also close to the
market of goods. The better combination between them can be similar to the economic
decision process applied in the study of public goods decisions, as we show through the
following graft:

The Optimal Market Size and Tieboutian Management

TDC, MDT, TPC

TDC

TPC

MC

MDT

M* MS

Through this graft, we can identify the Total Decision Cost (TDC), the Management
Decision Time (MDT), and the Total Production Cost (TPC) that are related with the
Market Size (MS). The result is MC, as Minimum Cost, and M*, as optimal size of the
market. At first, the TDC decrease with MS, but after optimal size (M*), becomes to
increase. The MD curve is decreasing, due to the increasing returns, because de market

18
size reduces their relative cost. The TPC curve increases with the market size,
accelerating it growth, after the optimal size of the market. A market within the global
market, mainly those within the integration process, is different of the traditional
imperfect market, where the production and the decision processes are, both
centralized. In this context, the management can be centralized and the production
must to be decentralized. In this global market the benefits of Nash equilibrium can be
reaches the optimal outcome of a game, without game, but with enough market to
improves returns and then, the quality, financing the competitive innovation. The
market already supports the financing of R&D by bigger and better enterprises.

Considering the imperfect market by its own traditional conditions using the model of
Cournot, the results it will be lower for both: to the market as a whole, and then to
consumers, and also to the firms at an individual level. In this traditional model the
strategy of a firm is to consider the production of another as a constant, that is, a market
without its own dynamic. In this case, within Tieboutian perspective, it is not expected
that demand can increase at domestic level and, mainly at international level, as a
whole. At the same time, considers the Marginal Cost (MgC) as a constant, and its
Marginal Revenue (MgR) is decreasing with increasing of production capacity. However,
the increasing returns, supported by innovation and higher marker size, allow also
higher Marginal Revenues until the Total decision Cost (TDC) reach its lower value.

Concluding, in this point, we can say the firms reach the optimal of Pareto, that is, the
maximum efficiency, considering also the social optimal with a maximum level of
redistribution using the international trade as a way to achieve the efficient by the
management, the cost and the market price. In this sense, our conclusion corroborate
with Phillip et al. (2012), arguing that prices depend more of market structure than local
production.

Conclusion
The market efficiency is subject to the market structure, and, then, to the market size.
The enterprises, families, regions and States can improve their own opportunities with
openness of the markets. The market efficiency within the Tieboutian perspective can
19
be reached through the decentralization in production process which increases the
market accessibility, namely, in quantity and quality, within a price competition
environment allowed by international trade. Then, the marginal rate of transformation
between labor and capital is stronger within imperfect competition market, benefited
from the larger markets, which improve the investment namely in R&D, and also the
centralization in financial management. In this sense, the Tieboutian strategy that has
been recommended to public services management, it is also useful to private market
efficiency, mainly, if it was complemented with the economic analysis of the public
decision process.

By this way, it is possible to identify the optimal market size in an imperfect competition
market, considering the market as a whole. We suggest this approach that can be
applied to market efficiency of the private goods, where the results will be a diminishing
in Total Decision Cost (TDC), that includes the Total Production Cost (TPC) and the
Management Decision (MD), until the optimal size (M*) be reached. This point it is those
where the market efficiency is maximized. Then, we can apply the public choice
approach to the international market structure. We suggest this Tieboutian theoretical
approach and the economic analysis of the public decision process, both as original
contributions to the study of market efficiency of the private goods, in the economic
literature.

References
Abel C. Fernandes (2008). Economia Pública: Eficiência Económica e Teoria das Escolhas Colectivas. Ed.
Sílabo, Lisboa.

Aghion, P., Fally, T., and Scarpetta, S (2007). Credit constrains as a barrier to the entry and post-entry
growth of firms, Economic Policy, pp. 731-779.

Bloom, N. Draca, M. and Van Reenen, J. (2011). Trade Induced Technical Change? The Impact of Chinese
Imports on Innovations, IT and Productivity, National Bureau of economic Research, working Paper 16717.

Claude d`Aspremont; David E. and Jean Tirole. (2000). Competition policy and game-theory reflections
based on the cement industry case in Market Structure Competition Policy: Game- theoretic Approaches
Ed. By George Norman and Jacques-François Thisse, Cambridge Univ. Press.

Elhanan Helpman and Paul Krugman (1987). Market Structure and Foreign Trade, the MIT Press.

Ermelinda Lopes (2012). Trade Balance as a Fiscal policy Goal. Journal of Business and Policy Research,
Vol.7, No 4, pp. 127-140.

20
Ermelinda Lopes (2013). Sectorial Productivity and Welfare. Paper submitted to 11th International
Industrial Organization Conference, May 17-19, 2013.

Geoff M.; Brigid O.; Mary O. and Kate R. (2008). Cross-Country Productivity Performance at Sector Level:
the UK Compared with the US, France and Germany, National Institute of Economics and Social Research,
BERR Occasional Paper no1.

Harry Huzinga and Luc Laeven (2008). International profit shifting within multinationals: A multi-country
perspective, Journal of Public Economics, No 92, pp. 1164-1182.

Jean, Tirole (1988). The Theory of Industrial Organization, Cambridge, Mass: The MIT Press.

John Cullis and Philip Jones (1998). Public Finance and Public Choice, Second Ed., Oxford Univ. Press.

José S.; Thierry M.; and Soledad Z. (2012). Market access in global and regional trade, Regional Science
and Urban Economics, No 42 pp. 1037-1052.

Neil Lee and Andrés Rodriguez-Pose (2012). Innovation and Special Inequality in Europe and USA. CEPR,
Discussion Paper No 9139.

OECD (2010). OECD statistics. www.oecd.org

Phillip A. Cartwright; David R. Kamerschen and Mei-Ying Huang (2012). Price Correlation and Granger
Causality Test for Market Definition, Review of industrial Organization, Vol. 4, No 2.

Raymond Atje and Gary C. Hufbauer (1996). The Market Structure Benefits of Trade and Investment
Liberalization, Institute for International Economics.

Robert S. Pindyck and Daniel L. Rubinfeld (2006). Microeconomia, 6º Ed. Person Prentice Hall.

Steven Berry and Joel Waldfogel (2010). Productivity Quality and Market Size. The Journal of Industrial
Economics, Vol. LVIII, No 1.

Tommaso Monacelli and Roberto Perotti (2011). Redistribution and the Multiplier, CEPR, Discussion Paper
Series no 8641.

World Trade Report (2004).

World Trade Report (2012).

21