EC311: International Economics

Imperfect Competition and Trade

Dr. Hussein Hassan

Email: Hussein.Hassan@reading.ac.uk
Office Hours: Wednesday 10-12pm and Friday 10-11am
Room: EM289

Spring 2020/21

1
Introduction

From Microeconomics, we know that there are four main market

structures which can be summarise as follows:

Type of Number Freedom of Nature of Examples

Market of Firms Entry Product
Perfect Very Unrestricted Undifferentiated Supermarkets
Competition Many
Monopolistic Many Unrestricted Differentiated Restaurants
Competition
Oligopoly Few Restricted Undifferentiated Airlines
/Differentiated
Monopoly One Restricted/ Unique Local water
Blocked Company

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A Review of Monopoly

In a Monopoly Market, there are many buyers, but only one single seller.
Given that there is only one Monopolist in the market, the monopolist
demand curve is the market demand curve. So, the monopolist can affect
the market price by adjusting his output level. The monopolist, like any
producer, aims at maximising his own profits:

Where, is total revenues and is total cost. By applying the first and second
order conditions, the output level which maximises profits is the one at
which:

3
A Review of Monopoly

Total Revenue Function (TR) which is equal to the quantity produced and
sold times price as follows:

If the Monopolist price is the inverse of his demand function and is given
by the following function:

Then,

4
A Review of Monopoly

The Monopolist Average Revenue Function (AR) is equal to the total

revenues (TR) divided by the quantity produced and sold.

The Monopolist Marginal Revenue Function (MR) which is the change in

total revenue arising from the sale of an additional unit of output. If the
production increases continuously, the MR is equal to the first derivate of
the TR function with respect to quantity:

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A Review of Monopoly

It is clear now that in a Monopoly

market:

 Given that the (inverse demand

function), then the AR curve
coincides with the demand
curve.

 Since the , the MR curve must lie

below the demand curve.

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A Review of Monopoly

From this Figure:

 The profit-maximising output

(here, equals to 4 units) occurs
when the MR curve intersects
with the MC curve.

 The Monopolist selling price

here is determined by the
intersection between the
equilibrium output line (4 units)
with the demand curve is equal
to $8.
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A Review of Monopoly

From this Figure:

 The Monopolist TR is equal to

the Price times the Quantity (i.e.
TR = B + E + F).

 The Monopolist TC is equal to

the ATC which is equal to $2
(determined by the intersection
between the equilibrium output
line with the AC curve)
multiplied by the Quantity (i.e.
area F).
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A Review of Monopoly

From this Figure:

 The Monopolist Profits which is

equal to Total Revenues minus
Total Cost is given here by the
summation of areas B and E (i.e.
Profits = B + E).

 Area A is here the consumer’s

surplus.

9
Dumping

Recall that:

 Dumping is the practice of charging a lower price for exported goods

than for the same goods sold domestically.

 Dumping is considered as an example of price discrimination in the

sense that charging different customers different prices.

 Dumping can be a profit maximising strategy because of differences in

foreign and domestic markets.

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Dumping

 Because the firm is a monopolist in the domestic market, the domestic

market demand curve is downward sloping, and the marginal revenue
curve lies below that demand curve.

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Dumping

 Because the firm is a small competitive firm in foreign markets, the

foreign market demand curve is horizontal, representing the fact that
exports are very responsive to small price changes.

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A Review of Monopolistic Competition

Monopolistic Competition is a market of an imperfectly competitive

industry which assumes that:

 Each firm is able to differentiate its product from that of competitors.

This allows it to have a monopoly in its particular product within an
industry.

 Each firm ignores the impact that changes in its own price will have
on the prices competitors set.

To make the model easier to understand, we assume here that all firms
have identical demand and cost functions. Thus, in equilibrium, all firms
charge the same price.

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A Review of Monopolistic Competition

In such symmetric equilibrium, an individual firm’s sales () is given by:

Where,

: The total sales of the industry

: The number of firms in the industry

: The price charged by the firm itself

: The average price charged by its competitors

: A constant term representing the responsiveness of a firm’s sales

to its price deviation from competitors’ price.

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A Review of Monopolistic Competition

From this figure, it is clear that:

 If the number of firms in an

industry is , the average cost
line intersects with the price
(inverse demand) curve at point
E at which the price is equal to
average cost.

 With , average costs become

higher than the selling price.
With , average costs become
lower than the selling price.
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A Review of Monopolistic Competition

Note here that:

 Firms have an incentive to enter the industry when profits are greater
than zero (i.e. Price > AC).

 Firms have an incentive to exit the industry when profits are less than
zero, i.e., losses (Price < AC).

 The equilibrium number of firms in an industry is that number at

which each firm achieves zero profits.

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Monopolistic Competition and Trade

Because international trade increases market size and industry sales,

trade is predicted to decrease average cost in an industry as follows:

Given that

Also, because international trade increases the variety of goods that

consumers can buy under monopolistic competition, it increases the
welfare of consumers.

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Monopolistic Competition and Trade

 Decreasing average costs shifts

the AC curve down from to and
consumers also benefit from a
decreased price.

 As a result of the international

trade, the number of firms in a
new international industry is
predicted to increase relative to
each national market.

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Example

Suppose that fixed costs for a firm in the automobile industry are £750
million and that variable costs are equal to £5000 per finished
automobile. Because more firms increase competition in the market, the
market price falls as more firms enter an automobile market:

P = 5000+ (30,000/N)

Where, N represents the number of firms in a market. Assume that the

initial size of the UK and the European automobile markets are 900,000
and 1.6 million, respectively.

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Example

1. Calculate the equilibrium number of firms in the UK and European

automobile markets without trade.

2. What is the equilibrium price of automobiles in the UK and Europe if

the automobile industry is closed to foreign trade?

3. Now suppose that the UK open up to free trade with Europe. How
many automobile firms will there be in this integrated-market? What
will be the new, global equilibrium price of an automobile?

4. Why are prices different in (3) than in (2)? Are consumers better off
with free trade? In what ways?

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