Quiz 6: Scale Economies, Imperfect Competition, and Trade

Business

Scale economies exist when unit (or average) cost declines as production during a period of time is larger. (1) The key role of scale economies in the analysis of markets that are monopolistically competitive is to provide an incentive for larger production levels of each variety of the industry's product. The product is differentiated, but it is not fully customized to each individual consumer's exact desires. Larger production runs of each variety of the product can benefit from scale economies. Still, these scale economies apply mainly to relatively small levels of production, so that a large number of firms and product varieties can exist and compete in the market. (2) The key role of scale economies in the analysis of oligopoly is that they drive firms to become large, so that a small number of firms come to dominate the market. These scale economies apply over a large range of output, so that firms that are large relative to the size of the market enjoy cost advantages over any smaller rivals.

If the government is going to permit free export of the pasta (no export taxes or export limits), then the government should choose to form the industry as a monopoly. The country is likely to gain more from trade if it charges a higher price to foreign buyers, because the country benefits from higher export prices and better terms of trade. A monopoly will charge higher prices (in order to maximize its profits), in comparison with the equilibrium price for a comparable but competitive industry. Because all of the product is exported, there is no concern with charging domestic consumers high prices. The goal is to charge foreign buyers high prices. The gains from better terms of trade accrue mainly to the monopoly as higher profits. This benefits the country as long as the monopoly is owned by the country's residents (or the country's government can gain some of these profits through taxation).

a.The market equilibrium price depends on how intensely Boeing and Airbus compete in order to gain sales. A low-price equilibrium occurs if Boeing and Airbus compete intensely to gain extra sales, including attempts to use price-cutting to "steal" sales from each other. A high-price equilibrium occurs if Boeing and Airbus recognize that price competition mainly serves to depress the profits of both firms, so that they both restrain their urges to compete using low prices.      b.From the perspective of the well-being of the United States or Europe, a high-price equilibrium could be desirable because it involves setting high prices on export sales to other countries. This equilibrium results in sales to domestic buyers at high prices, so there is some loss of pricing efficiency domestically. But the benefits to the country from charging high prices on exports and improving its terms of trade can easily be larger, so that overall the high-price equilibrium can be desirable.      c.The low-price outcome is desirable for a country like Japan or Brazil that imports all of its large passenger jet airplanes (e.g., for use by its national airlines). The country's terms of trade are better if import prices are lower.      d.Yes, Japan or Brazil still gains from importing airplanes. Some amount of "consumer surplus" is obtained by these countries-that is why they import even at the high price. But their surplus would be even greater if airplane prices were low.