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International trade and investment summary 5
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International trade and investment summary Krugman, P.R., Obstfeld, M. and Melitz, M.J. (2018), International Trade. Theory and Policy, 11th edition Week 5
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CH 8 KrugmanPricing decisions of firms are interdependent in an oligopoly market structure: Each firm in
an oligopoly will consider the expected responses of competitors when setting their price.
Product differentiation and internal economies of scale lead to trade between similar
countries with no comparative advantage differences between them. This is a very different
kind of trade than the one based on comparative advantage, where each country exports its
comparative advantage good.
Intra-industry trade: two-way exchanges of similar goods.
Performance varies widely across firms, so the effects of increased competition from trade
are far from inconsequential. As one would expect, increased competition tends to hurt the
worst-performing firms the hardest because they are the ones who are forced to exit. If the
increased competition comes from trade (or economic integration), then it is also associated
with sales opportunities in new markets for the surviving firms. Again, as one would expect, it
is the best-performing firms that take greatest advantage of those new sales opportunities
and expand the most. These composition changes have a crucial consequence at the level
of the industry: When the better-performing firms expand and the worse-performing ones
contract or exit, then overall industry performance improves. This means that trade and
economic integration can have a direct impact on industry performance: It is as if there was
technological growth at the level of the industry.
Compared to a firm with a higher marginal cost, a firm with a lower marginal cost will (1) set
a lower price but at a higher markup over marginal cost; (2) produce more output; and (3)
earn higher profits.
Increased competition holding market size S constant lowers the vertical intercept for
demand, leaving its slope unchanged: This is the induced inward shift from more
competition.
, Dumping occurs when a firm sets a lower price (net of trade costs) on exports than it
charges domestically. A consequence of trade costs is that firms will feel competition more
intensely on export markets because the firms have smaller market shares in those export
markets. This leads firms to reduce markups for their export sales relative to their domestic
sales.
Some multinationals replicate their production processes in foreign facilities located near
large customer bases = horizontal foreign direct investment (FDI).
Some multinationals break up their production chain and perform some parts of that chain in
their foreign facilities = vertical foreign direct investment (FDI).
These activities fall into two main categories:
(1) The affiliate replicates the production process (that the parent firm undertakes in its
domestic facilities) elsewhere in the world.
(2) the production chain is broken up, and parts of the production processes are transferred
to the affiliate location. Investing in affiliates that do the first type of activities is categorized
as horizontal FDI. Investing in affiliates that do the second type of activities is categorized as
vertical FDI.
Horizontal FDI is dominated by flows between developed countries; that is, both the
multinational parent and the affiliates are located in developed countries. The main reason
for this type of FDI is to locate production near a firm’s large customer bases. Hence, trade
and transport costs play a much more important role than production cost differences for
these FDI decisions.
Proximity concentration trade-off for FD = it is not cost effective to replicate the production
process too many times and operate facilities that produce too little output to take advantage
of those increasing returns.
As a substitute for horizontal FDI, a parent could license an independent firm to produce and
sell its products in a foreign location; as a substitute for vertical FDI, a parent could contract
with an independent firm (supplier) to perform specific parts of the production process in the
foreign location with the best cost advantage. This substitute for vertical FDI is known as
foreign outsourcing.
Offshoring represents the relocation of parts of the production chain abroad and groups
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