Economies of Scale Economies of Scale make it advantageous for each country to specialize in the production of only limited number of goods & services and to manufacture them in large quantities, partly for exports. Two types: (1)External economies- cost per unit depends on the size of industry, not the size of the firm. (2) Internal economies- cost per unit depends on the size of the individual firm

Internal economies and Differentiated Products ( Internal economies are inconsistent with perfect competition ) In monopolistic competition: (1) each firm can differentiate its product from that of its rivals. (2) each firm is assumed to take prices charged by its rivals as given.

A Model of Monopolistic Competition Q = firm’s sales S = total sales of the industry b = responsiveness of Q to the firm’s price increase, relative to the average price changed by competitions P = Variety (firm’s product) price = average price charged by competitors Demand for a variety, produced by a single firm:

SUMMARY Demand Cost

THE MARKET POWER SCHEDULE(The PP Schedule) Q = A-BPP = A/B - Q/B B = sb

The PP Schedule (continue) (The PP schedule) Markup: More n, smaller markup

Price Number of varieties P P The PP-Schedule

Costs F = fixed costs, c = marginal cost THE INTERNAL ECONOMIES SCHEDULE (The CC Schedule) more n Larger cost per unit

Number of firms Cost per unit, price CC: (AC = nF/S + c = P PP: (P = c + 1/bn) S given Larger nCompetition more intenseP Derivation of PP If each firm treats as given MARKET EQUILIBRIUM

# of firms Price CC: (P = nF/S + c) PP: (P = c + 1/bn) 1. An increase in F 2 An increase in the marginal cost of production

PP CC An increase in b (demand elasticity) Result: n goes up. Can get free competition free competition in the limiting case as

INTEGRATION OF TWO MARKETS Zero Profits due to Free Entry & Exit: = the zero profit number of firms in the industry = zero profit, profits-maximizing price Effects of MARKETS INTEGRATION - S rises, P falls. P n CC1 CC2 PP 1 2

Economies of Scale, Differentiated Products and Comparative Advantage If trade is costless and technologies are similar across trading partners economies we cannot say where firms will be located in the integrated market but the market definitely will support more firms and lower prices.

Two Goods: Food & Manufacturing Constant Returns ( The Hekscher-Ohlin Model) Home (capital Abundant) Foreign (labor abundant) Inter-industry trade homogenous differentiated products capital intensive good intensive in labor good

Two Goods: Food & Manufacturing Imperfect Competition Home (capital abundant) Foreign (labor abundant) Inter-industry trade homogenous differentiated products capital intensive good intensive in labor good Intra-industry trade