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.

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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.

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Preview
• Monopolistic competition and trade
• The significance of intra-industry trade
• Firm responses to trade: winners, losers, and industry
performance
• Dumping
• Multinationals and outsourcing

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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.

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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.

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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.

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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.

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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).

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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.
Q
• Marginal revenue equals MR  P  .
B
• 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.

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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.
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Monopoly: A Brief Review (3 of 4)
• Average cost is the cost of production (C) divided by
the total quantity of production (Q).
C F
AC   C
Q 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.

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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.
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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 P  AC.

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Monopolistic Competition (1 of 9)
• Monopolistic competition is a simple model of an
imperfectly competitive industry that assumes that each
firm
1. can differentiate its product from the product of
competitors, and
2. takes the prices charged by its rivals as given.

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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:

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Monopolistic Competition (3 of 9)
1 
Q  S   b  P  P 
n 
– 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

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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
s
equal share of the market Q 
n
– Average costs should depend on the size of the market
and the number of firms:
C F F
AC   C  n C
Q Q S

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Monopolistic Competition (5 of 9)
F 
AC  n    C
S 
• 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.

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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.
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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:
Q
MR  P   C
B

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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.
P  C  1  b n  
• Each firm’s markup over marginal cost
P  C  1  b n  
decreases with the number of competing firms.

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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.

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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.

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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: AC  n    C
F
S 
• 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.

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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.
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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

C  750,000,000  5,000  Q .  
• The average cost is therefore
 750,000,000 
AC     5,000.
 Q 

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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.

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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.

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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.
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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.

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Table 8.1 Hypothetical Example of Gains
from Market Integration
Home Market Foreign Market, Integrated Market,
Blank
before Trade before Trade after Trade

Industry output 900,000 1,600,000 2,500,000

(# of autos)
Number of firms 6 8 10
Output per firm 150,000 200,000 250,000
(# of autos)
Average cost $10,000 $8,750 $8,000
Price $10,000 $8,750 $8,000

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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.

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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.

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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.

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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
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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.

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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.
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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.
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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.
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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.

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Figure 8.7 Winners and Losers from
Economic Integration

'
(a) The demand curve for all firms changes from D to D 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, C , and the new one, C ' ,
are forced to exit. Some firms with the lowest marginal cost levels gain
from integration and their profits increase.
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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.
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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.
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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.
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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.
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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%

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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.
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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.

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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.

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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.”

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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.

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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.
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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.

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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.

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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.

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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.

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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.
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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.

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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.

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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.

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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.
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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.

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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.

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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.
F
– When foreign sales large Q  , exporting is more
t
expensive and FDI is the profit-maximizing choice.

– Low costs make more apt to choose FDI due to larger

sales.

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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.

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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.

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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.
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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:
1. 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.

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The Firm’s Decision Regarding Foreign
Direct Investment (7 of 8)
2. 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.

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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.
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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).

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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.

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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.

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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.

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Summary (1 of 4)
1. Internal economies of scale imply that more production at
the firm level causes average costs to fall.
2. 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.
3. Monopolistic competition allows for gains from trade
through lower costs and prices, as well as through wider
consumer choice.

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Summary (2 of 4)
4. Monopolistic competition predicts intra-industry trade,
and does not predict changes in income distribution
within a country.
5. Location of firms under monopolistic competition is
unpredictable, but countries with similar relative factors
are predicted to engage in intra-industry trade.

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Summary (3 of 4)
6. Dumping may be a profitable strategy when a firm faces
little competition in its domestic market and faces heavy
competition in foreign markets.
7. 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.

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Summary (4 of 4)
8. 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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Copyright

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