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1 Ch. 6: Economies of Scale, Imperfect Competition, and International Trade
11
Ch. 6: Economies of Scale, Imperfect Competition, and International Trade
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Constant Returns To ScaleConstant Returns To ScaleThe models we have looked at previously all The models we have looked at previously all
assumed constant returns to scale.assumed constant returns to scale.Constant returns to scale means if all of the Constant returns to scale means if all of the
resources are doubled, output will be resources are doubled, output will be doubled as well.doubled as well.
aQ = Q(aK,aL)aQ = Q(aK,aL)This assumption allows firms to have This assumption allows firms to have
increasing costs so that there could be many increasing costs so that there could be many firms in a market.firms in a market.
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Increasing Returns to ScaleIncreasing Returns to Scale It is possible that firms might experience It is possible that firms might experience
increasing returns to scale.increasing returns to scale.Doubling inputs more than doubles output.Doubling inputs more than doubles output.This is called economies of scale.This is called economies of scale. Internal economies of scale: per unit cost of Internal economies of scale: per unit cost of
production will decline as the firm expands.production will decline as the firm expands.External economies of scale: per unit cost of External economies of scale: per unit cost of
production will decline as the industry production will decline as the industry expands.expands.
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Monopolistic CompetitionMonopolistic Competition Internal economies of scale favor large Internal economies of scale favor large
firms.firms.The number of firms in the industry The number of firms in the industry
becomes small.becomes small.Oligopoly or monopoly results.Oligopoly or monopoly results.Declining average cost means that if the Declining average cost means that if the
firm can operate in a larger market it firm can operate in a larger market it can lower its costs hence its price.can lower its costs hence its price.
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An Example of Economies of ScaleOutput
5 Labor input
10 Avg Labor
2.00 10 15 1.50 15 20 1.33 20 25 1.25 25 30 1.20 30 35 1.17
If wage rate were $1, the last column would show average (per unit) cost.
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Labor Output Average Cost Marginal Cost Total Cost0 0 $15.00 $15.001 2 $10.00 $2.50 $20.002 5 $5.00 $1.67 $25.003 10 $3.00 $1.00 $30.004 15 $2.33 $1.00 $35.005 20 $2.00 $1.00 $40.006 25 $1.80 $1.00 $45.007 30 $1.67 $1.00 $50.00
$0.00$2.00
$4.00$6.00
$8.00$10.00
$12.00$14.00
$16.00
0 10 20 30 40
Quantity
Pric
e
Average Cost Marginal Cost
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Firm in Imperfect CompetitionFirm in Imperfect CompetitionDecision rule: compare MR with MC.Decision rule: compare MR with MC.
If MR>MC increase production.If MR>MC increase production. If MR<MC decrease production.If MR<MC decrease production.
MR (marginal revenue) is the contribution of MR (marginal revenue) is the contribution of the last unit of output to revenue.the last unit of output to revenue.
MC (marginal cost) is the contribution of the MC (marginal cost) is the contribution of the last unit of output to cost.last unit of output to cost.
Imperfect competition means when the firm Imperfect competition means when the firm increases its output, the price of the product increases its output, the price of the product falls: firm’s D is downward.falls: firm’s D is downward.
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Firm in Imperfect CompetitionFirm in Imperfect Competition
Demand curve facing a firm is downward Demand curve facing a firm is downward sloping.sloping.More output results in lower price because of More output results in lower price because of
the behavior of the consumers.the behavior of the consumers.Demand curve will determine the price Demand curve will determine the price
charged at each and every level of output.charged at each and every level of output.Marginal revenue will be below the price Marginal revenue will be below the price
because in order to sell an extra unit the because in order to sell an extra unit the price for all units has to be lowered.price for all units has to be lowered.
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Demand and Marginal RevenueDemand and Marginal Revenue
P
Q Q
P
D
MR DMR
Marginal revenue curve has a slope twice as steep as the demand curve.
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Demand and Marginal RevenueDemand and Marginal Revenue
Demand: P = a – bQ-b is the slope
Total Revenue: TR = PQPQ = aQ –bQ2
Marginal Revenue:MR = Δ(PQ)/ΔQMR = a – 2bQ-2b is the slope
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How Close Is P to MR?How Close Is P to MR?
MR = P – bQMR = P – bQP – MR = bQP – MR = bQThe steeper is the demand curve, the The steeper is the demand curve, the
larger is b, and the farther is P from MR.larger is b, and the farther is P from MR.The flatter is the demand curve, the The flatter is the demand curve, the
smaller is b, and the closer is P to MR.smaller is b, and the closer is P to MR.Why is the relationship in the book Why is the relationship in the book
different than here?different than here?Book: P-MR=Q/b; here: P-MR=bQBook: P-MR=Q/b; here: P-MR=bQ
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Firm Making Excess ProfitsFirm Making Excess Profits$
Q
AC
MCDMR
Q1
P1
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Long Run Equilibrium of a
Monopolistically Competitive Firm
D1MC
AC
Q1
Existence of excess profits attracts new firms into the industry. Increased competition reduces the market share for each firm. We show this by shifting the demand leftward. Excess profits remain until P=AC.In the long run a monopolistically competitive firm gets only normal profits.More firms forces firms to produce less at a higher AC.
P1
MR2
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LR Eqm and # of FirmsLR Eqm and # of FirmsIn the long-run, the higher the industry output (S), the higher will be the output of the firm (Q), given the number of firms (n).
In the long-run, the higher the competitive firms’ price (P), thehigher will be the price charged by the monopolistically competitive firm (P).
Let the Demand curve for the firm be:
Q = S [1/n – b (P – P)]
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L a b o r O u t p u t T o t a l C o s t A v g C o s t A F C A V C M C0 0 2 5 . 0 01 5 3 0 . 0 0 6 . 0 0 5 . 0 0 1 . 0 0 1 . 0 02 1 0 3 5 . 0 0 3 . 5 0 2 . 5 0 1 . 0 0 1 . 0 03 1 5 4 0 . 0 0 2 . 6 7 1 . 6 7 1 . 0 0 1 . 0 04 2 0 4 5 . 0 0 2 . 2 5 1 . 2 5 1 . 0 0 1 . 0 05 2 5 5 0 . 0 0 2 . 0 0 1 . 0 0 1 . 0 0 1 . 0 06 3 0 5 5 . 0 0 1 . 8 3 0 . 8 3 1 . 0 0 1 . 0 07 3 5 6 0 . 0 0 1 . 7 1 0 . 7 1 1 . 0 0 1 . 0 08 4 0 6 5 . 0 0 1 . 6 3 0 . 6 3 1 . 0 0 1 . 0 0
A C = T C / Q = A F C + A V C = F / Q + M C = F / Q + c
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Let P = Let P = PPQ = S [1/n – b (P – P)]Q = S/nAC = F/Q + cAC = F (n/S) + cTherefore, more firms there are, higher the AC. This will be our CC curve later.Larger the industry output, lower the AC.
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Marginal RevenueMarginal RevenueDemand: Q = S [1/n – b (P – P)]
Q = S/n – SbP + SbP SbP = S/n + SbP – Q P = 1/bn + P – Q/Sb
Total Revenue: PQ = Q/bn + QP – Q2/Sb
MR = d(PQ)/dQ = 1/bn + P – Q/Sb – Q/Sb MR = P – Q/Sb
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Firm EquilibriumFirm Equilibrium
MR = MCP – Q/Sb = cAt equilibrium, P = c + Q/SbIf all the firms charge the same price, then P = PQ = S/n Plug in:P = c + 1/bnThe more firms there are in the industry, the lower the price each firm will charge. This is our PP curve.
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2020Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 6-21
Monopolistic Competition (cont.)
• At some number of firms, the price that firms charge (which decreases in n) matches the average cost that firms pay (which increases in n).
• This number of firms is the number at which each firm has zero profits: price matches average cost.
• This number is the equilibrium number of firms.
2121Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 6-22
Monopolistic Competition (cont.)
• If the number of firms is greater than or less than n2, then in industry is not in equilibrium in the sense that firms have an incentive to exit or enter the industry.
Firms have an incentive to enter the industry when profits are greater than zero (price > average cost).
Firms have an incentive to exit the industry when profits are less than zero (price < average cost).
2222Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 6-23
Monopolistic Competition and Trade
• Because trade increases market size, trade is predicted to decrease average cost in an industry described by monopolistic competition.
Industry sales increase with trade leading to decreased average costs: AC = F(n/S) + c
• Because trade increases the variety of goods that consumers can buy under monopolistic competition, it increases the welfare of consumers.
Because average costs decrease, consumers can also benefit from a decreased price.
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Trade and Monopolistic Trade and Monopolistic CompetitionCompetition
Typically, firms in one country will produce Typically, firms in one country will produce a range of differentiated products different a range of differentiated products different than the firms in another country.than the firms in another country.
Trade will increase the market for all firms Trade will increase the market for all firms and allow a larger output by firms.and allow a larger output by firms.
Each firm and each country will specialize Each firm and each country will specialize in a different set of brands.in a different set of brands.
Exchange will allow consumers to have a Exchange will allow consumers to have a larger choice at lower prices.larger choice at lower prices.
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Pattern of TradePattern of Trade Interindustry trade reflects comparative Interindustry trade reflects comparative
advantage.advantage.Capital abundant country exports capital-Capital abundant country exports capital-
intensive goods.intensive goods. Intraindustry trade reflects economies of Intraindustry trade reflects economies of
scale that keep a country from producing a scale that keep a country from producing a full range of products.full range of products.
The pattern of intraindustry trade is The pattern of intraindustry trade is dependent on history and accident.dependent on history and accident.
Similar countries (K/L ratios) will engage in Similar countries (K/L ratios) will engage in intraindustry trade; different K/L ratios intraindustry trade; different K/L ratios support interindustry trade.support interindustry trade.
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The Significance of Intraindustry The Significance of Intraindustry TradeTrade
About 1/4 of world trade is intraindustry.About 1/4 of world trade is intraindustry. It is the main trade pattern between It is the main trade pattern between
industrialized nations.industrialized nations.The index of intraindustry trade is The index of intraindustry trade is
calculated by the following formula.calculated by the following formula. I = 1 - (|exports-imports|)/(exports+imports)I = 1 - (|exports-imports|)/(exports+imports)
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Significance of Intraindustry TradeIndexes of Intra-industry Trade for US, 1993
Inorganic Chemicals 0.99 Telecommunications eqpmt 0.69Power-generating machinery 0.97 Road vehicles 0.65Electrical machinery 0.96 Iron and steel 0.43Organic chemicals 0.91 Clothing and apparel 0.27Medical and pharmaceutical 0.86 Footwear 0.20Office machinery 0.81
The measure shown above is intra-industry trade/total trade. The measure would be zero for an industry in which the US was only an exporter or importer. It would be one in an industry where exports equaled imports. Sophisticated manufactured goods are exported by advanced nations and are probably subject to important economies of scale. Footwear and apparel are typically labor-intensive goods.
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Significance of Intraindustry TradeShares of Intraindustry Trade in Manufacturing
Country 1970 1980 1987United States 45.4 52.5 51.4Japan 23.6 23.6 22.2Germany 58.9 67.1 65.5France 65.5 71.6 72.3United Kingdom 57.8 66.8 68.8Italy 54.2 53.8 55.3Canada 44.8 47.0 55.7Netherlands 56.0 62.6 64.0Belgium 57.8 64.7 66.7Spain 25.8 45.2 56.4
Source: S. Vona, “Intra-Industry Trade: A Statistical Artifact of a Real Phenomenon?” Banca Nazionale Lavoro Quart. Rev., December 1990, p. 400. Quoted in D. Salvatore, International Economics, 5th ed., Prentice-Hall, New Jersey, 1995, p. 164.
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Welfare and Distribution Effects of Intraindustry Trade
• Intraindustry trade allows countries to benefit from larger markets. They produce fewer varieties of goods at a larger scale with higher productivity and lower costs. Consumers benefit from the increased range of choice. (Example: The North American Auto Pact of 1964.)
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Welfare and Distribution Effects of Intraindustry Trade
• Comparative advantage punishes the domestic industries competing with imports even though the overall well-being is raised. In intraindustry trade income distribution effects are small and there are substantial gains from trade. (Example: European Union).
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The North American Auto Pact of 1964
• Before 1965, tariff protection by Canada and the United States produced a Canadian auto industry that was largely self-sufficient. • The Canadian industry was one-tenth the size of US industry with labor productivity 30 percent lower.
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The North American Auto Pact of 1964
•Canadian plants were smaller and had to produce more varied products than US plants. They had to hold larger inventories, use less specialized machinery, shut down more often to change over from one model to another.
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The North American Auto Pact of 1964
• The Auto Pact of 1964 allowed auto companies to reorganize their production. Number of products made in Canada was drastically reduced; GM cut half of its models made in Canada. • The overall level of Canadian employment and production was maintained through specialization.
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The North American Auto Pact of 1964
• In 1962, Canada exported $16 million worth of automotive products to the US while importing $519 million worth. • By 1968, Canada exported $2.4 billion worth and imported $2.9 billion worth.• The gains were substantial: by early 1970s the Canadian industry was comparable to the US industry in productivity.
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European Union
• In 1957, the major countries of continental Europe established a free trade area in manufactured goods. • Trade within the EEC grew twice as fast as world trade during the 1960s.
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European Union
• There were no dislocations and political problems from the rapid growth of trade because it was entirely intraindustry.
• Instead of French electrical machinery workers being hurt while those in Germany gained, workers in both sectors gained from the increased efficiency of the integrated European industry.
• There were far fewer social and political problems from the rapid growth of trade than anyone anticipated.
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DumpingDumping
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DumpingDumping
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DumpingDumping If the more elastic demand curve is If the more elastic demand curve is
abroad, the firm will charge higher abroad, the firm will charge higher prices domestically and lower prices prices domestically and lower prices abroad.abroad.
It is conceivable that a firm might have It is conceivable that a firm might have more monopoly power (higher market more monopoly power (higher market share) at home than abroad.share) at home than abroad.
Import competitors cry foul in this case.Import competitors cry foul in this case.
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DumpingDumpingP
Q
DdomMRdom
Pfor=MRfor
MC
QtotalQdom
Pdom
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Trade restrictions in the U.S. in Trade restrictions in the U.S. in 19991999
Politics of SteelPolitics of Steel
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The VoteThe Vote The House voted decisively on Wednesday (March 17, The House voted decisively on Wednesday (March 17,
1999) to limit steel imports, ignoring opposition from the 1999) to limit steel imports, ignoring opposition from the Republican leadership and a White House warning that the Republican leadership and a White House warning that the measure would violate world trade agreements.measure would violate world trade agreements.
The 289-to-141 vote -- one short of the two-thirds margin The 289-to-141 vote -- one short of the two-thirds margin needed to override a Presidential veto -- displayed the needed to override a Presidential veto -- displayed the division in the Democratic Party over Clinton's free trade division in the Democratic Party over Clinton's free trade policies as well as the appeal of protectionism to policies as well as the appeal of protectionism to Republicans from the Rust Belt states. All but 13 House Republicans from the Rust Belt states. All but 13 House Democrats deserted the Administration. And 91 Democrats deserted the Administration. And 91 Republicans, a surprisingly large number, broke from their Republicans, a surprisingly large number, broke from their party's traditional free-trade position.party's traditional free-trade position.
Alison Mitchell, "By a Wide Margin, House Votes Steel Import Curbs," The New York Times, March 18, 1999, http://partners.nytimes.com/ 3/18/99
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The BillThe Bill The bill, the first major trade measure of this session of The bill, the first major trade measure of this session of
Congress, directs the United States to limit steel imports Congress, directs the United States to limit steel imports from other nations to their average monthly volume for the from other nations to their average monthly volume for the three-year period ending in July 1997. It would be up to three-year period ending in July 1997. It would be up to the Administration to decide whether to use quotas, tariffs the Administration to decide whether to use quotas, tariffs or voluntary agreements to achieve such a reduction, or voluntary agreements to achieve such a reduction, which would approach 30 percent.which would approach 30 percent.
The limits in the House bill would reduce steel imports by The limits in the House bill would reduce steel imports by 12 million tons a year from 1998 levels, while still allowing 12 million tons a year from 1998 levels, while still allowing about 29 million tons of steel into the country. At the about 29 million tons of steel into the country. At the height of the import surge in 1998, 41 million tons of steel height of the import surge in 1998, 41 million tons of steel was being imported annually.was being imported annually.
Alison Mitchell, "By a Wide Margin, House Votes Steel Import Curbs," The New York Times, March 18, 1999, http://partners.nytimes.com/ 3/18/99
4848
The Upsurge in ImportsThe Upsurge in Imports With world demand hurt by the Asian financial With world demand hurt by the Asian financial
crisis, foreign steelmakers have sold their crisis, foreign steelmakers have sold their products at low prices. The American industry products at low prices. The American industry has seen a drop in business while imports rose has seen a drop in business while imports rose 33 percent in 1998 before starting to subside 33 percent in 1998 before starting to subside in December.in December.
In February 1999, the Clinton Administration In February 1999, the Clinton Administration said it would impose tariffs to punish Japan said it would impose tariffs to punish Japan and Brazil for dumping steel in this country at and Brazil for dumping steel in this country at prices below cost and negotiated an prices below cost and negotiated an agreement with Russia to limit imports.agreement with Russia to limit imports.
Alison Mitchell, "By a Wide Margin, House Votes Steel Import Curbs," The New York Times, March 18, 1999, http://partners.nytimes.com/ 3/18/99
4949
Anti-Dumping DutiesAnti-Dumping Duties On Feb. 12, 1999, U.S. Commerce Department On Feb. 12, 1999, U.S. Commerce Department
announced import duties on Japanese and announced import duties on Japanese and Brazilian steel.Brazilian steel.
Japan, Brazil and Russia have been in a Japan, Brazil and Russia have been in a recession and their cheap steel exports to US recession and their cheap steel exports to US soared partly because of a strong US economy. soared partly because of a strong US economy. US steelmakers saw profits decline, forcing US steelmakers saw profits decline, forcing them to lay off workers and idle plants.them to lay off workers and idle plants.
In September 1998, Bethlehem Steel, LTV In September 1998, Bethlehem Steel, LTV Corp. and 10 others filed a complaint.Corp. and 10 others filed a complaint.
http://www.bloomberg.com/news2.cgi?T=news2_ft_topww.ht&s=380485412 2/13/99
5050
Anti-Dumping DutiesAnti-Dumping Duties Hot-rolled steel, used in pipe and machinery, Hot-rolled steel, used in pipe and machinery,
makes up 20% of US steel imports.makes up 20% of US steel imports. Dumping penalties range from 57% to 80% on Dumping penalties range from 57% to 80% on
Brazilian companies and 25% to 68% on Brazilian companies and 25% to 68% on Japanese.Japanese.
Japan Steel Information Center in New York Japan Steel Information Center in New York claimed that since September 1998 no hot-rolled claimed that since September 1998 no hot-rolled steel was being shipped to the US.steel was being shipped to the US.
Japan is the largest steel exporter to the US: 1998 Japan is the largest steel exporter to the US: 1998 total $4.1 billion.total $4.1 billion.
Bethlehem stock rose 9%, CSN, Brazil stock fell Bethlehem stock rose 9%, CSN, Brazil stock fell 4.5%.4.5%.
Http://www.bloomberg.com/news2.cgi?T=news2_ft_topww.ht&s=380485412 2/13/99
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Political PowerPolitical Power Although the industry employs only 260,000 people, all Although the industry employs only 260,000 people, all
but seven states produce some steel. And often only but seven states produce some steel. And often only a handful of angry constituents is enough to sway a a handful of angry constituents is enough to sway a congressman's vote. The decisive factor has been a congressman's vote. The decisive factor has been a slick $4m campaign involving rallies in 43 cities and slick $4m campaign involving rallies in 43 cities and emotive TV and newspaper ads.emotive TV and newspaper ads.
The industry claims that a surge in imports last year is The industry claims that a surge in imports last year is to blame for plunging profits and some 10,000 lay-offs.to blame for plunging profits and some 10,000 lay-offs.
Independent estimates suggest that only 3,000 jobs Independent estimates suggest that only 3,000 jobs have been lost (though, admittedly, with no less pain have been lost (though, admittedly, with no less pain for the workers concerned) in an economy that created for the workers concerned) in an economy that created 2.5m net new jobs last year.2.5m net new jobs last year.
The Economist, March 20, 1999, p. 31
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Political PowerPolitical Power Despite rising imports, 11 of the top 13 steel Despite rising imports, 11 of the top 13 steel
companies made profits last year.companies made profits last year. This year, steel imports from Japan and This year, steel imports from Japan and
Russia have all but ceased. In April, Russia have all but ceased. In April, prohibitive duties on Japanese and Brazilian prohibitive duties on Japanese and Brazilian steel were imposed; Russia agreed instead to steel were imposed; Russia agreed instead to a quota restricting its exports. a quota restricting its exports.
In January President Clinton offered steel In January President Clinton offered steel makers a subsidy package that includes makers a subsidy package that includes $300m of tax breaks.$300m of tax breaks.
The Economist, March 20, 1999, p. 31
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Dumping RulesDumping Rules Brazil’s currency dropped 36% against the Brazil’s currency dropped 36% against the
USD after it was allowed to float in January USD after it was allowed to float in January 1999 making its exports cheaper.1999 making its exports cheaper.
The International Trade Commission, the US The International Trade Commission, the US agency that evaluates impact of trade on agency that evaluates impact of trade on national industries, said last year that national industries, said last year that Russian companies were dumping steel to Russian companies were dumping steel to the US at between 107 and 199 percent the US at between 107 and 199 percent below the cost of production.below the cost of production.
Http://www.bloomberg.com/news2.cgi?T=news2_ft_topww.ht&s=380485412 2/13/99
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Dumping RulesDumping Rules In the case of Japan and Brazil, dumping In the case of Japan and Brazil, dumping
is defined as selling products in the US is defined as selling products in the US more cheaply than at home.more cheaply than at home.
With Russia, which the US considers a With Russia, which the US considers a “non-market” economy, it is defined as “non-market” economy, it is defined as selling below the cost of production in a selling below the cost of production in a comparable market economy like Poland.comparable market economy like Poland.
Http://www.bloomberg.com/news2.cgi?T=news2_ft_topww.ht&s=380485412 2/13/99
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Protection in USProtection in US Melvyn Krauss says US has more than 8000 Melvyn Krauss says US has more than 8000
separate tariffs, with taxes on some imports separate tariffs, with taxes on some imports exceeding 100%.exceeding 100%.
Thousands of import quotas exist on clothing, Thousands of import quotas exist on clothing, textiles, cheese, sugar and others.textiles, cheese, sugar and others.
Thousands of foreign companies are forced to pay Thousands of foreign companies are forced to pay “antidumping penalties” for charging low prices to “antidumping penalties” for charging low prices to their American customers.their American customers.
A 1979 Treasury Department study estimated that A 1979 Treasury Department study estimated that trade barriers cost American consumers 8-10 times trade barriers cost American consumers 8-10 times as much as they benefit American producers.as much as they benefit American producers.
Melvyn Krauss, How Nations Grow Rich, Oxford University Press, 1997
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External Economies of ScaleExternal Economies of Scale When economies of scale occur for an individual When economies of scale occur for an individual
firm, monopolistic competition applies.firm, monopolistic competition applies. In many cases, concentrating production of an In many cases, concentrating production of an
industry in one or few locations reduces industry in one or few locations reduces industry’s costs, even if the individual firms industry’s costs, even if the individual firms remain small.remain small. Silicon Valley in CaliforniaSilicon Valley in California Investment banking industry in New YorkInvestment banking industry in New York Entertainment industry in HollywoodEntertainment industry in Hollywood
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External Economies of ScaleExternal Economies of Scale There are three reasons why a cluster of firms There are three reasons why a cluster of firms
may be more efficient than an individual firm in may be more efficient than an individual firm in isolation. (Alfred Marshall)isolation. (Alfred Marshall) They can support specialized suppliersThey can support specialized suppliers It allows labor market poolingIt allows labor market pooling Helps foster knowledge spilloversHelps foster knowledge spillovers
External economies will not operate unless the External economies will not operate unless the national industry is large enough.national industry is large enough. The supply curve is downward sloping.The supply curve is downward sloping.
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Specialized SuppliersSpecialized Suppliers Development of new products requires the use of Development of new products requires the use of
specialized equipment or support services. An specialized equipment or support services. An individual company does not provide a large enough individual company does not provide a large enough market to keep these suppliers in business.market to keep these suppliers in business.
In Silicon Valley, engineers left semiconductor In Silicon Valley, engineers left semiconductor companies to start firms that manufactured capital companies to start firms that manufactured capital goods freeing individual producers from the expense of goods freeing individual producers from the expense of developing capital equipment internally.developing capital equipment internally.
The dense network of specialized suppliers has given The dense network of specialized suppliers has given firms in Silicon Valley considerable advantage over firms in Silicon Valley considerable advantage over firms elsewhere.firms elsewhere.
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Labor Market PoolingLabor Market Pooling A cluster of firms can create a pooled market for A cluster of firms can create a pooled market for
workers with highly specialized skills.workers with highly specialized skills. If two firms in different locations employ specialized If two firms in different locations employ specialized
workers, depending on the demand, they may seek a workers, depending on the demand, they may seek a lot or just a few. If specialized workers are equally lot or just a few. If specialized workers are equally divided in the locations, the firm with the high divided in the locations, the firm with the high demand will not find enough workers, the firm with demand will not find enough workers, the firm with the low demand will leave some workers the low demand will leave some workers unemployed. If everyone is in the same location, unemployed. If everyone is in the same location, allocation will be more efficient.allocation will be more efficient.
In Silicon Valley, it is apparently commonplace to In Silicon Valley, it is apparently commonplace to leave a job on Friday and start a new one on leave a job on Friday and start a new one on MondayMonday..
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Knowledge SpilloversKnowledge Spillovers In the modern economy, knowledge is at least as In the modern economy, knowledge is at least as
important an input like labor, capital and raw important an input like labor, capital and raw materials.materials.
An important source of technical know-how is the An important source of technical know-how is the informal exchange of information and ideas that take informal exchange of information and ideas that take place at a personal level.place at a personal level.
When an industry is concentrated in a fairly small When an industry is concentrated in a fairly small area, employees of different companies mix socially area, employees of different companies mix socially and talk freely about technical issues.and talk freely about technical issues.
This kind of informal information flow means that it is This kind of informal information flow means that it is easier for companies to stay near the technological easier for companies to stay near the technological
frontier than it is for companies elsewhere.frontier than it is for companies elsewhere.
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External Economies and TradeExternal Economies and Trade
External economies can causecountries to get “locked in” toundesirable patterns of specialization and can evenlead to losses from internationaltrade. Countries that start out aslarge producers tend to remainlarge producers. This continueseven if some other country canpotentially produce goods morecheaply.
D
ACSWISS
ACTHAI
C0P1
Q1
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Welfare with External EconomiesWelfare with External EconomiesTrade based on external economies has more ambiguous effects on national welfare than either comparative advantage or economies of scale at the firm level. There may be gains to the world economy. It is also possible that a country might be worse off than it would have been without trade.
ACSWISS
ACTHAI
DWORLDDTHAI
C0P1P2
Thailand imports watches fromSwitzerland at P1. The price islow enough to block entry byThai producers. If Thailand were to ban watch imports, itcould provide watches at a priceof P2.
