Chapter 8: Internal returns to scale

Marginal Cost (MC)

The cost of producing one more unit, c

Improved competitive environment

More productive firms will stay in the market, and the less productive firms will exit the market
→ Surviving firms are more productive

Market share

The amount of the market that one firm covers

Monopolistic competition

1) differentiated goods
2) technology exhibits increasing returns to scale (e.g., a firms needs a factory to produce)
3) many producers in the market

Demand Curve

Inverse demand curve

Operating profit

(P-c)*Q

Equilibrium

MR=MC

Firms optimal behaviour

Who will exit the market?

Firms with c>c*

Who will stay in the market?

Firms with c*≥c

What happens when the market increases?

S increases → flatter slope
The Demand curve flattens. The intersect will be lower.
There will be more demand for any price.

n and p-bar changes
b stays the same

The operating profit curve will be steeper. Fewer firms will stay in the market as it pushes high-cost firms out

Slope

Slope=-1/(s*b)

Trade cost

a cost added to the cost of the product when exporting it to another market. Only the more effective firm will export.

Horizontal FDI

when firms expand their sales horizontally → located and sell their products in more markets

To sell abroad
- produce at home and pay trade costs, t, to ship the goods
- start production abroad by paying a fixed cost, F, to open a factory

Vertical FDI

Invest in developing countries to lower their production costs by moving some parts of production from home to foreign

scale-fixed cost tradeoff

The most productive firms are more likely to do Vertical FDI, as they produce more and can therefore lower their MC

Price dumping

When a firms sells a product at a lower price (net trade cost) on a foreign market

Who will export with trade cost?

the firms with c+t

Who will no longer export with trade cost?

the firms with c+t>c*

Imperfect competition

Firms can influence the prices

Marginal revenue

The demand curve with double the slope
(demand curve equation)*Q and take first order derivative

MR=P-(Q/B)
P-MR=Q/B

Slope parameter

B (will be given)

Firms total cost

C=F+c*Q

AC

AC=C/Q=F/Q+c

c

Marginal cost, cost of producing one extra unit

F

Fixed cost, the intersect of the supply curve

Demand in monopolistic competition

The larger the Q, the larger the S
When P increases, quantity increases
when "P-bar" increases, the quantity increases (if the price of other firms increases, more people will buy our product)

Competitive market

More competition from other firms will lower the sales from any firm at any price (given a fixed market size)

Assumptions for the model

1) firms are symmetric
a) Produce differentiated goods
b) They have the same demand directed at their product
c) They operate with the same technology
2) properties of firms' demand
3) properties of firms' technology

The CC-curve

When there's firm symmetry (Q=S/n, P=P-bar)
AC=(n*f)/S +c

AC increases with number of firms
S is fixed, when n increases, AC increases as each firm produces less

PP-curve

Firm acts as local monopolies

mark-up

P-c=1/(n*b)
measures a firms market power

International trade

In market with economies of scale, the market size (S) constraints:
1) number of operating firms,n, i.e., the number of product varieties
2) The quantity produced bt each firm S/n which affects AC

Integrated market

1) each country can produce less variaties → lower AC
2) consumers enjoy greater variety

The effect of market size

CC: When S increases, AC decreases
PP: Nothing happens
mark-ups will not change directly with market size


Reward low-cost firms → expand demand = more consumers
Penalise high-cost firms

Optimal behaviour

In the long run firms produce up until the point where Profit=0

International trade with external economies to scale

→ Trade increases market size, which lowers
→ intersept of inverse demand (and decreases marginal cost cutoff, c*)
→ Slope of the inverse demand (increase demand for each price level)