(International Trade) Econ Online Questions on 11/03, Only 2 Short Answers!!

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International Economics: Theory and Policy

Eleventh Edition

Chapter 8

Firms in the Global Economy: Export Decisions, Outsourcing, and Multinational Enterprises

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Learning Objectives (1 of 2)

8.1 Understand how internal economies of scale and product differentiation lead to international trade and intra-industry trade.

8.2 Recognize the new types of welfare gains from intra-industry trade.

8.3 Describe how economic integration can lead to both winners and losers among firms in the same industry.

Learning Objectives (2 of 2)

8.4 Explain why economists believe that “dumping” should not be singled out as an unfair trade practice, and why the enforcement of antidumping laws leads to protectionism.

8.5 Explain why firms that engage in the global economy (exporters, outsourcers, multinationals) are substantially larger and perform better than firms that do not interact with foreign markets.

8.6 Understand theories that explain the existence of multinationals and the motivation for foreign direct investment across economies.

Preview

Monopolistic competition and trade

The significance of intra-industry trade

Firm responses to trade: winners, losers, and industry performance

Dumping

Multinationals and outsourcing

Introduction (1 of 3)

Internal economies of scale result when large firms have a cost advantage over small firms, causing the industry to become uncompetitive.

Internal economies of scale imply that a firm’s average cost of production decreases the more output it produces.

Introduction (2 of 3)

Perfect competition that drives the price of a good down to marginal cost would imply losses for those firms because they would not be able to recover the higher costs incurred from producing the initial units of output.

As a result, perfect competition would force those firms out of the market.

In most sectors, goods are differentiated from each other and there are other differences across firms.

Introduction (3 of 3)

Integration causes the better-performing firms to thrive and expand, while the worse-performing firms contract.

Additional source of gain from trade: As production is concentrated toward better-performing firms, the overall efficiency of the industry improves.

Study why those better-performing firms have a greater incentive to engage in the global economy.

The Theory of Imperfect Competition

In imperfect competition, firms are aware that they can influence the prices of their products and that they can sell more only by reducing their price.

This situation occurs when there are only a few major producers of a particular good or when each firm produces a good that is differentiated from that of rival firms.

Each firm views itself as a price setter, choosing the price of its product.

Monopoly: A Brief Review (1 of 4)

A monopoly is an industry with only one firm.

An oligopoly is an industry with only a few firms.

In these industries, the marginal revenue generated from selling more products is less than the uniform price charged for each product.

To sell more, a firm must lower the price of all units, not just the additional ones.

The marginal revenue function therefore lies below the demand function (which determines the price that customers are willing to pay).

Monopoly: A Brief Review (2 of 4)

Assume that the demand curve the firm faces is a straight line Q = A – B(P), where Q is the number of units the firm sells, P the price per unit, and A and B are constants.

Marginal revenue equals

Suppose that total costs are C = F + c(Q), where F is fixed costs, those independent of the level of output, and c is the constant marginal cost.

Figure 8.1 Monopolistic Pricing and Production Decisions

A monopolistic firm chooses an output at which marginal revenue, the increase in revenue from selling an additional unit, equals marginal cost, the cost of producing an additional unit. This profit-maximizing output is shown as QM; the price at which this output is demanded is PM. The marginal revenue curve MR lies below the demand curve D because, for a monopoly, marginal revenue is always less than the price. The monopoly’s profits are equal to the area of the shaded rectangle, the difference between price and average cost times the amount of output sold.

Monopoly: A Brief Review (3 of 4)

Average cost is the cost of production (C) divided by the total quantity of production (Q).

Marginal cost is the cost of producing an additional unit of output.

A larger firm is more efficient because average cost decreases as output Q increases: internal economies of scale.

Figure 8.2 Average Versus Marginal Cost

This figure illustrates the average and marginal costs corresponding to the total cost function C = 5 + x. Marginal cost is always 1; average cost declines as output rises.

Monopoly: A Brief Review (4 of 4)

The profit-maximizing output occurs where marginal revenue equals marginal cost.

At the intersection of the MC and MR curves, the revenue gained from selling an extra unit equals the cost of producing that unit.

The monopolist earns some monopoly profits, as indicated by the shaded box, when

Monopolistic Competition (1 of 9)

Monopolistic competition is a simple model of an imperfectly competitive industry that assumes that each firm

can differentiate its product from the product of competitors, and

takes the prices charged by its rivals as given.

Monopolistic Competition (2 of 9)

A firm in a monopolistically competitive industry is expected to sell

more as total sales in the industry increase and as prices charged by rivals increase.

less as the number of firms in the industry decreases and as the firm’s price increases.

These concepts are represented by the function:

Monopolistic Competition (3 of 9)

Q is an individual firm’s sales

S is the total sales of the industry

n is the number of firms in the industry

b is a constant term representing the responsiveness of a firm’s sales to its price

P is the price charged by the firm itself

P is the average price charged by its competitors

Monopolistic Competition (4 of 9)

Assume that firms are symmetric: all firms face the same demand function and have the same cost function.

Thus all firms should charge the same price and have

equal share of the market

Average costs should depend on the size of the market and the number of firms:

Monopolistic Competition (5 of 9)

As the number of firms n in the industry increases, the average cost increases for each firm because each produces less.

As total sales S of the industry increase, the average cost decreases for each firm because each produces more.

Figure 8.3 Equilibrium in a Monopolistically Competitive Market

The number of firms in a monopolistically competitive market, and the prices they charge, are determined by two relationships. On one side, the more firms there are, the more intensely they compete, and hence the lower is the industry price. This relationship is represented by PP. On the other side, the more firms there are, the less each firm sells and therefore the higher is the industry’s average cost. This relationship is represented by CC. If price exceeds average cost (that is, if the PP curve is above the CC curve), the industry will be making profits and additional firms will enter the industry; if price is less than average cost, the industry will be incurring losses and firms will leave the industry. The equilibrium price and number of firms occurs when price equals average cost, at the intersection of PP and CC.

Monopolistic Competition (6 of 9)

If monopolistic firms face linear demand functions, Q = A − B(P),

where A and B are constants.

When firms maximize profits, they should produce until marginal revenue equals marginal cost:

Monopolistic Competition (7 of 9)

As the number of firms n in the industry increases, the price that each firm charges decreases due to increased competition.

Each firm’s markup over marginal cost

decreases with the number of competing firms.

Monopolistic Competition (8 of 9)

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).

At this long-run equilibrium number of firms in the industry, firms have no incentive to enter or exit the industry.

Monopolistic Competition (9 of 9)

If the number of firms is greater than or less than the equilibrium number, then firms have an incentive to exit or enter the industry.

Firms have an incentive to exit the industry when price < average cost.

Firms have an incentive to enter the industry when price > average cost.

Monopolistic Competition and Trade (1 of 2)

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:

Because trade increases the variety of goods that consumers can buy under monopolistic competition, it increases the welfare of consumers.

And because average costs decrease, consumers can also benefit from a decreased price.

Figure 8.4 Effects of a Larger Market

An increase in the size of the market allows each firm, other things equal, to produce more and thus have lower average cost. This is represented by a downward shift from CC1 to CC2. The result is a simultaneous increase in the number of firms (and hence in the variety of goods available) and a fall in the price of each.

Gains from an Integrated Market: A Numerical Example (1 of 3)

Suppose that b = 1/30,000, fixed cost F = $750,000,000 and a marginal cost of c = $5,000 per automobile.

The total cost is

The average cost is therefore

Gains from an Integrated Market: A Numerical Example (2 of 3)

Suppose there are two countries, Home and Foreign.

Home has annual sales of 900,000 automobiles; Foreign has annual sales of 1.6 million.

The two countries are assumed (for now) to have the same costs of production.

Gains from an Integrated Market: A Numerical Example (3 of 3)

The integrated market supports more firms, each producing at a larger scale and selling at a lower price than either national market does on its own.

Everyone is better off as a result of the larger market with integration:

Consumers have a wider range of choices, and

Each firm produces more and is therefore able to offer its product at a lower price.

Figure 8.5 Equilibrium in the Automobile Market (1 of 2)

(a) The Home market: With a market size of 900,000 automobiles, Home’s equilibrium, determined by the intersection of the PP and CC curves, occurs with six firms and an industry price of $10,000 per auto. (b) The Foreign market: With a market size of 1.6 million automobiles, Foreign’s equilibrium occurs with eight firms and an industry price of $8,750 per auto.

Figure 8.5 Equilibrium in the Automobile Market (2 of 2)

(c) The combined market: Integrating the two markets creates a market for 2.5 million autos. This market supports 10 firms, and the price of an auto is only $8,000.

Table 8.1 Hypothetical Example of Gains from Market Integration

Blank	Home Market before Trade	Foreign Market, before Trade	Integrated Market, after Trade
Industry output (# of autos)	900,000	1,600,000	2,500,000
Number of firms	6	8	10
Output per firm (# of autos)	150,000	200,000	250,000
Average cost	$10,000	$8,750	$8,000
Price	$10,000	$8,750	$8,000

Monopolistic Competition and Trade (2 of 2)

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.

The Significance of Intra-Industry Trade (1 of 2)

Intra-industry trade refers to two-way exchanges of similar goods.

Two new channels for welfare benefits from trade:

Benefit from a greater variety at a lower price.

Firms consolidate their production and take advantage of economies of scale.

A smaller country stands to gain more from integration than a larger country.

The Significance of Intra-Industry Trade (2 of 2)

About 25–50% of world trade is intra-industry.

Most prominent is the trade of manufactured goods among advanced industrial nations, which accounts for the majority of world trade.

For the United States, industries that have the most intra-industry trade—such as pharmaceuticals, chemicals, and specialized machinery—require relatively larger amounts of skilled labor, technology, and physical capital.

Table 8.2 Indexes of Intra-Industry Trade for U.S. Industries, 2009

Metalworking Machinery	0.97
Inorganic Chemicals	0.97
Power-Generating Machines	0.86
Medical and Pharmaceutical Products	0.85
Scientific Equipment	0.84
Organic Chemicals	0.79
Iron and Steel	0.76
Road Vehicles	0.70
Office Machines	0.58
Telecommunication Equipment	0.46
Furniture	0.30
Clothing and Apparel	0.11
Footwear	0.10

Firm Responses to Trade

Increased competition tends to hurt the worst-performing firms — they are forced to exit.

The best-performing firms take the greatest advantage of new sales opportunities and expand the most.

When the better-performing firms expand and the worse-performing ones contract or exit, overall industry performance improves.

Trade and economic integration improve industry performance as much as the discovery of a better technology does.

Intra-Industry Trade in Action: The North American Auto Pact of 1964 and NAFTA (1 of 5)

Before 1965, tariff protection by Canada and the United States produced a Canadian auto industry that was largely self-sufficient, neither importing nor exporting much.

The Canadian auto industry was about 1/10 the size of the United States and had a labor productivity about 30 percent lower than that of the United States.

Most Canadian plants produced several different things, requiring the plants to shut down periodically to change over from producing one item to producing another, to hold larger inventories, to use less specialized machinery.

Intra-Industry Trade in Action: The North American Auto Pact of 1964 and NAFTA (2 of 5)

The United States and Canada agreed in 1964 to establish free trade in automobiles, which allowed the auto companies to reorganize their production.

The overall level of Canadian production and employment was maintained.

Canadian subsidiaries cut how many products were made in Canada. Production levels for the models produced in Canada rose dramatically, as those Canadian plants became one of the main (or only) supplier of that model for the whole North American market.

Canada imported the models from the United States that it was no longer producing.

Intra-Industry Trade in Action: The North American Auto Pact of 1964 and NAFTA (3 of 5)

Both exports and imports increased sharply.

By the early 1970s, the Canadian industry was comparable to the U.S. industry in productivity.

Later on, this transformation of the automotive industry was extended to include Mexico.

This process continued with the implementation of NAFTA (the North American Free Trade Agreement between the United States, Canada, and Mexico).

For each model of car, there is typically a plant in one of these three countries that sells to the whole North American market.

Intra-Industry Trade in Action: The North American Auto Pact of 1964 and NAFTA (4 of 5)

The manufacture of auto parts was also consolidated throughout the North American market.

In the first decade following NAFTA, trade in automotive parts between the United States and Mexico more than doubled in both directions, and then doubled again in the ensuing decade, highlighting the increasing importance of intra-industry trade.

Figure 8.7 Winners and Losers from Economic Integration

(a) The demand curve for all firms changes from D to

It is flatter,

and has a lower vertical intercept. (b) Effects of the shift in demand on the operating profits of firms with different marginal cost ci. Firms with

marginal cost between the old cutoff,

and the new one,

are forced to exit. Some firms with the lowest marginal cost levels gain from integration and their profits increase.

Intra-Industry Trade in Action: The North American Auto Pact of 1964 and NAFTA (5 of 5)

Concerns raised over a few final assembly plants relocating from the United States to Mexico rarely mentions the large growth of U.S. autos and parts exports to Mexico: Over two-thirds of Mexican automotive imports originated in the U.S. in 2002.

Ending NAFTA likely would not would not result in higher car production in the United States.

Lower demand for U.S. imports in Mexico and Canada (along with higher prices for all consumers) would lead to lower car production in the United States.

Only car production outside North America would increase.

Figure 8.6 Performance Differences Across Firms

(a) Demand and cost curves for firms 1 and 2. Firm 1 has a lower marginal cost than firm 2: c1 < c2. Both firms face the same demand curve and marginal revenue curve. Relative to firm 2, firm 1 sets a lower price and produces more output. The shaded areas represent operating profits for both firms (before the fixed cost is deducted). Firm 1 earns higher operating profits than firm 2. (b) Operating profits as a function of a firm’s marginal cost ci. Operating profits decrease as the marginal cost increases. Any firm with marginal cost above c* cannot operate profitably and shuts down.

Trade Costs and Export Decisions (1 of 2)

Most U.S. firms do not report any exporting activity at all — sell only to U.S. customers.

In 2007, only 35% of U.S. manufacturing firms reported any exports.

Even in industries that export much of what they produce, such as chemicals, machinery, electronics, and transportation, fewer than 40 percent of firms export.

A major reason why trade costs reduce trade so much is that they drastically reduce the number of firms selling to customers across the border.

Trade costs also reduce the volume of export sales of firms selling abroad.

Trade Costs and Export Decisions (2 of 2)

Trade costs added two important predictions to our model of monopolistic competition and trade:

Why only a subset of firms export, and why exporters are relatively larger and more productive (lower marginal costs).

Overwhelming empirical support for this prediction that exporting firms are bigger and more productive than firms in the same industry that do not export.

In the United States, in a typical manufacturing industry, an exporting firm is on average more than twice as large as a firm that does not export.

Differences between exporters and nonexporters are even larger in many European countries.

Table 8.3 Proportion of U.S. Firms Reporting Export Sales by Industry, 2007

Printing	15%
Furniture	16%
Wood Products	21%
Apparel	22%
Fabricated Metal	30%
Petroleum and Coal	34%
Transportation Equipment	57%
Machinery	61%
Chemicals	65%
Electrical Equipment and Appliances	70%
Computer and Electronics	75%

Figure 8.8 Export Decisions with Trade Costs

(a) Firms 1 and 2 both operate in their domestic (Home) market. (b) Only firm 1 chooses to export to the Foreign market. It is not profitable for firm 2 to export given the trade cost t.

Dumping (1 of 2)

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 (2 of 2)

Dumping can be a profit-maximizing strategy:

A firm with a higher marginal cost chooses to set a lower markup over marginal cost.

Therefore, an exporting firm will respond to the trade cost by lowering its markup for the export market.

This strategy is considered to be dumping, regarded by most countries as an “unfair” trade practice.

Protectionism and Dumping (1 of 4)

A U.S. firm may appeal to the Commerce Department to investigate if dumping by foreign firms has injured the U.S. firm.

The Commerce Department may impose an “anti-dumping duty” (tax) to protect the U.S. firm.

Tax equals the difference between the actual and “fair” price of imports, where “fair” means “price the product is normally sold at in the manufacturer's domestic market.”

Protectionism and Dumping (2 of 4)

Next, the International Trade Commission (ITC) determines if injury to the U.S. firm has occurred or is likely to occur.

If the ITC determines that injury has occurred or is likely to occur, the anti-dumping duty remains in place.

Protectionism and Dumping (3 of 4)

Most economists believe that the enforcement of dumping claims is misguided.

Trade costs have a natural tendency to induce firms to lower their markups in export markets.

Such enforcement may be used excessively as an excuse for protectionism.

In the early 1990s, the bulk of anti-dumping complaints were directed at developed countries.

But since 1995, developing countries have accounted for the majority of anti-dumping complaints.

Among those countries, China has attracted a particularly large number of complaints.

Protectionism and Dumping (4 of 4)

A nonmarket economy with substantial export growth, China has been subject to antidumping duties on:

TVs, furniture, crepe paper, hand trucks, shrimp, ironing tables, plastic shopping bags, iron pipe fittings, saccharin, solar panels, tires, and cold-rolled steel.

These duties are as high as 78% on color TVs, 266% for cold-rolled steel, and 330% on saccharin.

Chinese cost data likely distorted by subsidized loans, rigged markets, and the controlled yuan.

Data from other developing nations regarded as market economies used instead.

Multinationals and Outsourcing (1 of 6)

Foreign direct investment refers to investment in which a firm in one country directly controls or owns a subsidiary in another country.

If a foreign company invests in at least 10% of the stock in a subsidiary, the two firms are typically classified as a multinational corporation.

10% or more of ownership in stock is deemed to be sufficient for direct control of business operations.

Multinationals and Outsourcing (2 of 6)

Greenfield FDI is when a company builds a new production facility abroad.

Brownfield FDI (or cross-border mergers and acquisitions) is when a domestic firm buys a controlling stake in a foreign firm.

Greenfield FDI has tended to be more stable, while cross-border mergers and acquisitions tend to occur in surges.

Multinationals and Outsourcing (3 of 6)

Developed countries have been the biggest recipients of inward FDI.

much more volatile than FDI going to developing and transition economies.

Steady expansion in the share of FDI flowing to developing and transition countries.

Accounted for half of worldwide FDI flows since 2009.

Sales of FDI affiliates are often used as a measure of multinational activity.

Figure 8.9 Inflows of Foreign Direct Investment, 1970-2015

Worldwide flows of FDI have significantly increased since the mid-1990s, though the rates of increase have been very uneven. Historically, most of the inflows of FDI have gone to the developed countries in the OECD. However, the proportion of FDI inflows going to developing and transition economies has steadily increased over time and accounted for roughly half of worldwide FDI flows since 2009.

Multinationals and Outsourcing (4 of 6)

Two main types of FDI:

Horizontal FDI when the affiliate replicates the production process (that the parent firm undertakes in its domestic facilities) elsewhere in the world.

Vertical FDI when the production chain is broken up, and parts of the production processes are transferred to the affiliate location.

Multinationals and Outsourcing (5 of 6)

Vertical FDI is mainly driven by production cost differences between countries (for those parts of the production process that can be performed in another location).

Vertical FDI is growing fast and is behind the large increase in FDI inflows to developing countries.

Multinationals and Outsourcing (6 of 6)

Horizontal FDI is dominated by flows between developed countries.

Both the multinational parent and the affiliates are usually 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.

Figure 8.10 Outward Foreign Direct Investment for Top 25 Countries, Yearly Average 2013-2015

Developed countries dominate the list of the top countries whose firms engage in outward FDI. More recently, firms from some big developing countries such as China and India have performed significantly more FDI.

Source: United Nations Conference on Trade and Development, World Investment Report, 2015.

The Firm’s Decision Regarding Foreign Direct Investment (1 of 8)

Proximity-concentration trade-off:

High trade costs associated with exporting create an incentive to locate production near customers.

Increasing returns to scale in production create an incentive to concentrate production in fewer locations.

The Firm’s Decision Regarding Foreign Direct Investment (2 of 8)

FDI activity concentrated in sectors with high trade costs.

When increasing returns to scale are important and average plant sizes are large, we observe higher export volumes relative to FDI.

Multinationals tend to be much larger and more productive than other firms (even exporters) in the same country.

The Firm’s Decision Regarding Foreign Direct Investment (3 of 8)

The horizontal FDI decision involves a trade-off between the per-unit export cost t and the fixed cost F of setting up an additional production facility.

If t(Q) > F, costs more to pay trade costs t on Q units sold abroad than to pay fixed cost F to build a plant abroad.

When foreign sales large

exporting is more

expensive and FDI is the profit-maximizing choice.

Low costs make more apt to choose FDI due to larger sales.

The Firm’s Decision Regarding Foreign Direct Investment (4 of 8)

The vertical FDI decision also involves a trade-off between cost savings and the fixed cost F of setting up an additional production facility.

Cost savings related to comparative advantage make some stages of production cheaper in other countries.

The Firm’s Decision Regarding Foreign Direct Investment (5 of 8)

Foreign outsourcing or offshoring occurs when a firm contracts with an independent firm to produce in the foreign location.

In addition to deciding the location of where to produce, firms also face an internalization decision: whether to keep production done by one firm or by separate firms.

Figure 8.11 U.S. International Trade in Business Services, 1986–2015

U.S. service offshoring is captured by U.S. imports of business services. Although service offshoring has dramatically increased over the past decade, U.S. inshoring (exports of business services) has grown even faster. The net balance is positive and has also substantially increased over the past decade.

The Firm’s Decision Regarding Foreign Direct Investment (6 of 8)

Internalization occurs when it is more profitable to conduct transactions and production within a single organization. Reasons for this include:

Technology transfers: transfer of knowledge or another form of technology may be easier within a single organization than through a market transaction between separate organizations.

Patent or property rights may be weak or nonexistent.

Knowledge may not be easily packaged and sold.

The Firm’s Decision Regarding Foreign Direct Investment (7 of 8)

Vertical integration involves consolidation of different stages of a production process.

Consolidating an input within the firm using it can avoid holdup problems and hassles in writing complete contracts.

But an independent supplier could benefit from economies of scale if it performs the process for many parent firms.

The Firm’s Decision Regarding Foreign Direct Investment (8 of 8)

Foreign direct investment should benefit the countries involved for reasons similar to why international trade generates gains.

Multinationals and firms that outsource take advantage of cost differentials that favor moving production (or parts thereof) to particular locations.

FDI is very similar to the relocation of production that occurred across sectors when opening to trade.

There are similar welfare consequences for the case of multinationals and outsourcing: Relocating production to take advantage of cost differences leads to overall gains from trade.

Whose Trade Is It? (1 of 4)

Large bilateral trade deficit between the United States and China.

$305 billion in 2015,

accounts for 60 percent of the overall U.S. trade deficit (in goods and services) with the rest of the world,

prominently featured in the press and by politicians (often as a sign of unfair trade practices).

Whose Trade Is It? (2 of 4)

Buying an iPhone 7 (32 GB) from Apple in the United States is recorded as a $225 import from China (where the iPhone is assembled and tested).

Of the $225 total manufacturing cost, only $5 stems from assembly and testing (performed in China).

The remaining $220 represents the iPhone’s component costs, which are overwhelmingly produced outside of China.

spread throughout Asia (Korea, Japan, and Taiwan are the largest suppliers), Europe, and the Americas.

Whose Trade Is It? (3 of 4)

75 sites in the United States contribute to the production of iPhone components and employ 257,000 U.S. workers.

Many of the component producers outside the United States employ U.S. researchers and engineers.

For example, the Korean company Samsung—one of the largest suppliers of iPhone components (by value)—operates research facilities in Texas and California that employ several thousand workers.

Whose Trade Is It? (4 of 4)

The true bilateral deficit between the United States and China (at value added) is estimated to be roughly half of the reported bilateral trade deficit based on gross value.

The trade deficits with Germany, Japan, and Korea are magnified when measured as value added, because those countries manufacture many of the components that are assembled in China and then imported as final goods into the United States.

Leaves the overall U.S. trade deficit (with the rest of the world) unchanged.

Summary (1 of 4)

Internal economies of scale imply that more production at the firm level causes average costs to fall.

With monopolistic competition, each firm can raise prices somewhat above those on competing products due to product differentiation but must compete with other firms whose prices are believed to be unaffected by each firm’s actions.

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

Summary (2 of 4)

Monopolistic competition predicts intra-industry trade, and does not predict changes in income distribution within a country.

Location of firms under monopolistic competition is unpredictable, but countries with similar relative factors are predicted to engage in intra-industry trade.

Summary (3 of 4)

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

Multinationals are typically larger and more productive than exporters, which in turn are larger and more efficient than firms that sell only to the domestic market.

Summary (4 of 4)

Multinational corporations undertake foreign direct investment when proximity is more important than concentrating production in one location.

Firms produce where it is most cost-effective — abroad if the scale is large enough. They replicate entire production process abroad or locate stages in different countries.

Firms also decide whether to keep transactions within the firm or contract with another firm.

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