MANEESH PDEPT. OF APPLIED ECONOMICS

INTERNATIONAL TRADE: The economic interaction among different nations involving the exchange of goods and services, that is, exports and imports.

The guiding principle of international trade is comparative advantage, which indicates that every country, no matter their level of development, can find something that it can produce cheaper than another country.

INTRODUCTION

International trade is the sale and purchase of goods across national boundaries.

Unrestricted International Trade – If international trade is not restricted, buyers & sellers in one country may purchase goods (& services) from any other country.

Hence – each buyer and seller has the option to make a transaction either in the domestic market or abroad.

The choice depends on where you can get the higher (lower) price if you are selling (buying)

• Countries engage in international trade for two basic reasons:

–Countries trade because they differ either in their resources or in technology.

–Countries trade in order to achieve scale economies or increasing returns in production.

Advantages to consider:

Enhance your domestic competitiveness Increase sales and profits Gain your global market share Reduce dependence on existing markets Exploit international trade technology Extend sales potential of existing products Stabilize seasonal market fluctuations Enhance potential for expansion of your business Sell excess production capacity Maintain cost competitiveness in your domestic market

AdvantagesMeeting our Needs

• Allows Countries to have access to many goods that we are unable to produce ourselves (equipments, motor vehicles….)

• Trading Partners get something they need by trading something that they do not need

AdvantagesJob Creation

• Foreign businesses buy Countries products and services, which leads to more jobs

Attracting Investment

• Investment follows trade

• Many foreign companies, when demand is proven through trade, will invest in an office, factory or distribution warehouse in the country to simplify their trade and reduce costs

• This investment creates other jobs in construction, sales and office management

New Technology and Material

Development of new technology promotes competitiveness and profitability

Newly developed technology sold through patents to foreign companies – collecting annual fees, royalty percentage or a one-time payment, outlined very specifically in a contract

Diverse Products and Services

Foreign trade opens up the world as a market, delivering a wide range of foods, high fashions, and new inventions to the domestic market

Foreign travel, banking, consultation and other services are also available to the domestic consumers.

Businesses must consider that their competition for similar products and services is no longer just in the same city but anywhere in the world.

Disadvantages to keep in mind:

• You may need to wait for long-term gains

• Hire staff to launch international trading

• Modify your product or packaging

• Develop new promotional material

• Incur added administrative costs

• Dedicate personnel for traveling

• Wait long for payments

• Apply for additional financing

• Deal with special licenses and regulations

The Four Types of Market Structure

Copyright © 2004 South-Western

• Tap water•Cable TV

Monopoly

• Novels• Movies

MonopolisticCompetition

• Tennis balls• Crude oil

Oligopoly

Number of Firms?

Perfect

• Wheat• Milk

Competition

Type of Products?

Identicalproducts

Differentiatedproducts

Onefirm

Fewfirms

Manyfirms

Monopolistic competition is a market structure inwhich there are many competing producers, each producing a differentiated product, and there is free entry and exit in the long run.

Product differentiation takes three main forms: by style or type, by location, or by quality

MONOPOLİSTİC COMPETİTİON

PRODUCT DIFFERENTIATION

Product differentiation plays an even more crucial role in monopolistically competitive industries.

Why?Tacit collusion is virtually impossible when

there are many producers. Hence, product differentiation is the only way monopolistically competitive firms can acquire some market power.

• Product differentiation is crucial to monopolistic competition

• People value variety, even if it is not material (real)

• Product differentiation takes place in buyer’s mind

• Variety is valued but costly – we pay for it

CONTINUED….

• Product differentiation does not necessarily mean there are any physical differences among products– They might all be the same, but how they are

sold may make all the difference

• There are, of course, some very real physical product differences.– Buyers often differentiate based on real

physical differences, but differentiation is still taking place in the buyers mind, and it may or may not be based on real physical differences

CONTINUED…

Advertising• In monopolistically competitive industries,

product differentiation and markup pricing lead naturally to the use of advertising.

• In general, the more differentiated the products, the more advertising firms buy.

• Economists disagree about the social value of advertising.

A monopolistically competitive firm will always prefer tomake an additional sale at the going price, so it will engage in advertising to increase demand for its product and enhance its market power.

Advertising and brand names that provide useful information to consumers are economically valuable. But they are economically wasteful when their only purpose is to create market power.

BRAND NAME

• A brand name is valuable to a firm; it makes the demand less elastic and can enable the firm to earn higher profits.

• Once a consumer has had a positive experience with a good, the price elasticity of demand for that good typically decreases—the consumer becomes loyal to the product.

COMPETITION WITH DIFFERENTIATED PRODUCTS

• The Monopolistically Competitive Firm in the Short Run

– Short-run economic profits encourage new firms to enter the market. This:

• Increases the number of products offered.

• Reduces demand faced by firms already in the market.

• Incumbent firms’ demand curves shift to the left.

• Demand for the incumbent firms’ products fall, and their profits decline.

PRICE DISCRIMINATION

Question – Does price discrimination raise or lower profit?

Price discrimination – selling the same good or service at a number of different prices.

Answer – Price discrimination is a marketing means to increase economic profit

• Methods of price discrimination

Discriminate among groups of buyers

works when different buying groups are willing

to pay different prices (on the average) for the same good or service

Example: Airline travel – prices target business travelers vs. leisure time travelers

discriminator is advance notice, shorter the notice, the higher the price

Some Examples of Price Discrimination

– Doctors often charge rich patients more than poor patients• They may have one price for those with insurance

and another price for those without insurance

– Movies in the evening cost more than those in the early afternoon

– Senior citizen, youth, and student discounts

– New and used cars

– Youth fairs on airlines.

Motives for Price Discrimination

• In most cases, price discrimination is basically a mechanism for rationing goods and services

• The main motivation for price discrimination is to raise profits

– The greater the price discrimination, the greater the profits because buyers lose some of their “consumer surplus”

– If price discrimination were carried to its logical conclusion, we would have perfect price discrimination• The buyers would lose all of their “consumer surplus”

MANY SELLERS

When there are many sellers, they do not take into account rivals’ reactions.

The existence of many sellers makes collusion difficult.

Monopolistically competitive firms act independently.

There are many firms competing for the same group of customers.

Product examples include books, CDs, movies, computer games, restaurants, piano lessons, cookies, furniture, etc.

Easy Entry of New Firms in the Long Run

There are no significant barriers to entry.

Barriers to entry prevent competitive pressures.

Ease of entry limits long-run profit.

• The monopolistic competition model can be used to show how trade leads to:

–A lower average price due to scale economies

– The availability of a greater variety of goods due to product differentiation

– Imports and exports within each industry (intra-industry trade)

Monopolistic Competition and Trade

• The Effects of Increased Market Size– The number of firms in a monopolistically

competitive industry and the prices they charge are affected by the size of the market.

Monopolistic Competition and Trade

Cost C, and

Price, P

Number

of firms, n

CC1

n1

P1

1

PP

n2

P2

2

CC2

Monopolistic Competition and Trade

The Effects of Increased Market Size

• Gains from an Integrated Market:

• International trade allows creation of an integrated market that is larger than each country’s market.

• It thus becomes possible to offer consumers a greater variety of products and lower prices.

Monopolistic Competition and Trade

• Assumptions:

– There are two countries: Home (the capital-abundant country) and Foreign.

– There are two industries: manufactures (the capital-intensive industry) and food.

– Neither country is able to produce the full range of manufactured products by itself due to economies of scale.

Economies of Scale and Comparative Advantage

Home

(capital abundant)

Foreign

(labor abundant)

Manufactures Food

Trade without increasing returns

– If manufactures is a monopolistically competitive sector, world trade consists of two parts:

• Intraindustry trade

– The exchange of manufactures for manufactures

• Interindustry trade

– The exchange of manufactures for food

Monopolistic Competition and Trade

Home

(capital abundant)

Foreign

(labor abundant)

Manufactures Food

Interindustry

trade

Intraindustry

trade

Trade with Increasing Returns and Monopolistic Competition

Main differences between interindustry and intraindustry trade:

• Interindustry trade reflects comparative advantage, whereas intraindustry trade does not.

• The pattern of intraindustry trade itself is unpredictable, whereas that of interindustry trade is determined by underlying differences between countries.

• The relative importance of intraindustry and interindustry trade depends on how similar countries are.

Production and Pricing Under Monopolistic Competition.

Monopolistic Competition and Intra-Industry Trade.

• About one-fourth of world trade consists of intra-industry trade.

• Intra-industry trade plays a particularly large role in the trade in manufactured goods among advanced industrial nations, which accounts for most of world trade.

Significance of Intraindustry trade

• Intra industry trade allows countries to benefit from larger markets.

• Gains from intra industry trade will be large when economies of scale are strong and products are highly differentiated.

– For example, sophisticated manufactured goods.

.

Continued…

–Consumers gain more variety at a lower prices than those that would prevail without trade.

–Production is more efficient. (Larger market allows full exploitation of economies of scale.)

–When similar countries trade, the resulting change in the income distribution (capital v. labor) will be small

– Thus, everyone may gain from trade.

DUMPING

• Dumping is the practice of charging a lower price for exported goods than for goods sold domestically.

• Dumping is an example of price discrimination: the practice of charging different customers different prices.

• Price discrimination and dumping may occur only if

– imperfect competition exists: firms are able to influence market prices.

– markets are segmented so that goods are not easily bought in one market and resold in another.

• Dumping may be a profit maximizing strategy because of differences in foreign and domestic markets.

• One difference is that domestic firms usually have a larger share of the domestic market than they do of foreign markets.

– Because of less market dominance and more competition in foreign markets, foreign sales are usually more responsive to price changes than domestic sales.

– Domestic firms may be able to charge a high price in the domestic market but must charge a low price on exports if foreign consumers are more responsive to price changes.

Continued…

• Two kinds of behavior arise in the general oligopoly setting that are excluded by assumption from the monopolistic competition model:

– Collusive behavior:• Can raise the profits of all firms at the expense of consumers

• May be managed through explicit agreements or through tacit coordination strategies

– Strategic behavior:• Is adopted by firms to affect the behavior of competitors in a

desirable way

• Deters potential rivals from entering an industry

Limitations of Monopolistic Competition

CONCLUSION

Although the level and the rate of economicdevelopment depend primarily on internal conditionsin developing nations, international trade cancontribute significantly to the development process.

Some economists believed that international tradeand the functioning of the present internationaleconomic system benefited developed nations at theexpense of developing nations

A monopolistically competitive market is characterized by three attributes: many firms, differentiated products, and free entry.

Monopolistic competition allows for gains from trade through lower costs and prices, as well as through wider consumer choice.

In general, trade may be divided into two kinds:

Two-way trade in differentiated products within an industry (intraindustry trade).Trade in which the products of one industry are exchanged for products of another (interindustry trade).

Dumping may be a profitable strategy when a firm faces little competition in its domestic market and faces heavy competition in foreign markets.

Monopolistic competition have a significant influence on international trade. The existence of large number of sellers expand the market size and supply of differentiated products.

The competition of firms through differentiated price may cause losses, therefore they prefer non price competition like advertisements, guarantees and warranties.

Under monopolistic competition a country can achieve variety of goods at low price and help to expand market and integration of market

Any Questions?