CAP 8

Questão 1

Internal economies of scale imply that as output increases, the average cost of
production falls i.e. average cost curve slopes downwards. Whenever average
cost is decreasing, the marginal cost will be less than the average cost because
average cost includes the cost of those initial units that were produced at higher
unit costs. So, the marginal cost curve lies below the average cost curve. In this
situation, if a firm sets its price equal to marginal cost (the cost of producing one
extra unit of output), the average cost will be greater than the price; thus the
concerned firm incur losses. The firms cannot sustain these losses and must shut
down in the long run. Represent the graphs showing the price determination
under perfect competition and internal economies as follows:

n figure (a) firm under perfect competition sets the price equal to marginal cost
where it is also equal to average cost, marginal revenue and average revenue.
While, in the figure (b), firm under internal economies sets the price equal to
marginal cost, so, the average cost being greater than the marginal cost, will incur
losses. Thus, firms can’t set price equal to marginal cost when there are internal
economies of scale because they incur losses.

Questão 2

If the two countries integrate their automobile industry with a third country, the
number of firms, output per firm and the price per automobile is calculated as
shown below; The relation between average cost fixed cost and marginal cost is
given by the below expression.
Where,

Average Cost is represented as AC,

Fixed Cost is represented as F,

Marginal Cost is represented as C,

Output of the firm is represented as Q,

Price is represented as P,

Number of firms is represented as n,

Constant (responsiveness of a firm’s sales to its price) is represented as b,

Calculate number of firms:

Since average cost per unit is same as the price, equate the average cost with
price;
However, S gives total output of the industry and it is equal to as shown
below;

otal output S is equal to the total market of the three countries;

Therefore, total market output of the three countries is 6.25 million.

Furthermore;

ubstitute S, b, and F value into equation :

However, fraction of 15.8 firms does not exist, there will be 15 firms in the
automobile industry (not 16) as the 16th firm cannot cover its average cost or its
average cost is higher than the market price of the industry.

Calculate Output per firm:

Therefore, output per firm is 41,666 units

Calculate price per automobile:

Therefore, price per automobile is $7,000.

Therefore, the total number of firms is 15, output per firm is 41,666 units, and the
equilibrium price charged is $7,000.

Questão 3

(a) It is given that P = 17,000 + ( ), where P is price and n is the numbers of

firms.Now, as we know that = (for )=

Where, AC = average cost F = fixed cost Q = output of firm C = variable cost

(marginal cost depends on variable cost and is independent of fixed cost)

S = each country’s market for the automobile sector

Since average cost per unit is same as the price; AC=P,

17,000 + ( )= ..... (1)

Now, the value of S in United States is 300 million. So, Substituting the values
for S, F, and C in equation (1) we get the value of n for United States; n = 3.
Similarly the value for S in Europe is 533 million. Substituting the required values
in equation (1), we get the value of n for Europe; n = 4.
(b) Substituting the value for n in the equation P = 17,000 + ( )we get the

value of P for United States; PUS = 17,000+ = Similarly, substituting

the value for n in the equation P = 17,000 + ( )we get the value of P for

Europe; PE = 17,000 + =

(c) The combined value of S in United States and Europe is 833 million (300
million+533 million). Substituting the values for S, F, and C in equation (1) we get
the value of n for both United States and Europe; n = 5.

Now, substituting the

value for n in the equation P = 17,000 + ( )we get the value of P for United

States and Europe; P = 17,000 + = 17,030

(d) In both countries, the price of automobiles has fallen to $17,030 per
automobile due to free trade. So consumers have to pay less for a purchase of
an automobile after trade is opened. Not only this, consumers in each country
have more variety of brands available after trade. In United States, the number
of brands increases from three to five while that in Europe increases from four to
five. Thus consumers in both countries are better off with trade.

Questão 4

(a)Yes, it can be profitable for few firms to adopt the new technology but not for
other firms because when the firms adopt new technology, it increases their fixed
cost of production. On the other hand, it reduces their marginal cost of production.
It is known that the lower the marginal cost is; the higher is the operating profits
(profits before the deduction of fixed cost) of the firm. This is true for all firms.
Now, if the benefits from lower marginal costs outweigh the simultaneous
increase in fixed cost, the overall profits (operating profits minus the fixed cost)
will be positive. On the other hand, if the increase in fixed cost outweighs the
benefits from decrease in marginal cost, then the overall profits will be negative.
Whether the overall profits of firms are positive or negative depends upon the
size of the output the firms produce. Given an increased fixed cost and a
decreased marginal cost (due to new technology), firms which have more
production of output will have high positive overall profits. In such cases, the firm
will adopt the new technology. Firms with lower level of output will have negative
overall profits and hence, it will not adopt the new technology.

(b) Suppose there is another firm, say firm 3, which produces 800 units. With the
adoption of new technology both firm 2 and firm 3 will get overall profits. Suppose
there is a trade cost, which will be added to the marginal cost. Suppose further
that firm 2 and firm 3 incur a trade cost, which makes the firm 2 non profitable
and hence it may not adopt new technology while exporting. However, firm 3 still
have positive overall profits. If the firms are non- exporting, trade cost will not
exist. Hence, firm 3 will have positive overall profits and thus will adopt the new
technology.

Questão 5

a) Dumping is a practice of exporting goods at lower prices than the home market
prices. The practice of dumping always injures the domestic firms of the importing
country. When the domestic firms of the importing country finds that the price
difference between goods domestic price and its export price is more, the
exporter is accused of dumping. Now, if the number of firms in the domestic
market of the importing country is more, then most of the firms are price followers
than price setters. The pricing of the product is not entirely in their hands. In this
case dumping at lower price affects its market and there might be accusation of
dumping on the exporter. However, it should be noted that if the firms of the
importing country are able to utilize their capacities to the optimum and still there
is market for the product they are not much bothered about the dumping. If the
number of firms are less the pricing is entirely in their hands and they too will try
to match its pricing with the dumping goods.

b) Yes, a firm from a small country is likely to be accused of dumping when it

exports to a large country because the dumping accusation does not depend
upon the size of the country; rather it depends upon the size of the market.
Countries like Taiwan; a small country produces goods at a low cost of production
and discriminates the price of the goods internationally; that is charging a high
domestic price and low export price and thus, is likely to be accused of dumping.

Questão 6

Foreign direct investment, or FDI refers to the investment made in one country
by individuals or business entities from another foreign country. It involves a direct
control of resources.

a) When the Saudi businessman buys $10 million of IBM stock, it is not a case
of direct foreign investment, rather it is a case of portfolio investment. It is just
a passive investment in the stocks of another country’s company.

b) If the Saudi businessman purchases an apartment building in New York city,

then it is a case of direct foreign investment because the rent he earns on the
building is considered as his returns on investment.
c) Since direct investment includes investment through purchase of shares, so, it
is a case of direct foreign investment.

d) It is not a case of direct foreign investment. The Italian firm did not invest
in the Russian plant, rather it got the contract for constructing the plant and
managing it.

Questão 7

Horizontal FDI: When a company uses the same production process to set up
facilities in a foreign country near customer base, this is categorized as Horizontal
FDI. Vertical FDI: When a company divide their production chain and carry some
part of the production chain in a foreign country, this is categorized as Vertical
FDI.

(a) It is a case of Horizontal FDI because the U.S multinational takes the complete
production process in nation E by opening several restaurants. There is an
outflow from the U.S and inflow into the nation E.

(b) It is a case of Vertical FDI because the French multinational is buying only the
ownership rights and splitting the production process. There is an outflow from
nation F and inflow into nation C.

(c) It is a case of Horizontal FDI as the V. Company start new dealership, that is,
sale automobile in the US. There is an outflow from nation G and inflow into the
US.

(d) It is a case of Vertical FDI as the Swiss multinational, Company N sets up the
full production process in nation B. There is an outflow from nation S and inflow
into nation B.

Questão 8

Internal economies of scale are observed by a single firm when the average cost
of production (cost per unit of output) falls for a range of output. Internal
economies of scale are the outcome of the efficiency of the firm. As the output
increases, the average cost of output falls until the firm reaches its minimum
efficient scale i.e. the scale of production where the firm has maximized its
efficiency in production. After reaching its minimum efficient scale, any increase
in output increases the average cost of production and this may lead to internal
diseconomies of scale. In such situation, a firm which enjoys economies of scale
can avoid the internal diseconomies of scale by producing the same good in more
than one production unit. So, it makes sense for a firm to produce more of good
by increasing its number of production facilities. However, this act of a firm
depends upon the transport cost and labor availability and its cost.
Questão 9

Apparel and footwear industry is labor intensive. Major proportion of its cost
involves labor (wages), so, these firms try to locate in places where labor is
abundant or cheap. Technology is not a major part in its production. These firms
may have its own sources of raw materials or the required quality and quantity of
raw materials may not be available at places (countries) where they outsource
the production to. So, these labor intensive industries don’t integrate with the
suppliers there. Whereas in the capital intensive industries, capital is a major part
of its output and availability of raw materials play a minor role. In other words,
they are more technology dependent. In these cases the firms may integrate with
local suppliers.

Questão 10

When intermediate goods are produced within a multinational’s affiliate network,

the shipments of those intermediate goods are referred as intra-firm trade (that is
trade between two subsidiaries of a company). Much of the intra-firm trade
consists of trade in parts, components and other inputs from which final goods
are made. Such trade mainly takes place among the technology driven
companies (that is capital intensive industries) like automobile sector and
electronic goods. So, greater proportion of trade occurs within the firms of capital
intensive industries.