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Alternative Theory #3: Differentiated Products

Terms in this set (25)

3 Critical Assumptions
1. Different firms produce different type of product (ppl have different preferences)
2. Industry exists in multiple countries
3. The MES of each firm in the industry is large relative to the DOMESTIC market (NOT large fraction of global)
4. The dominant preferences in each country determine which types of product are produced there
Simplifying assumptions of toy model
1. Qd (domestic market) in each country is given, and the same # in every Qd (vertical line)
2. Each firm, produces ONE type of the product
3. All firms have IDENTICAL LRATC curves
4. (Qdomestic market) / (MES of each firm) = a small integer (in each country that produces this good)
MES is large relative to ________ market so ______ firms in a ________ can produce at MES but _______ firms in the WORLD can produce at MES
MES is large relative to DOMESTIC market so FEW firms in a COUNTRY can produce at MES but MULTIPLE firms in the WORLD can produce at MES
Autarky and the Choices based on Alt. Theory 3 (options)
1. 2 types of product at MES price so 2 firms
2. More than 2 types but price > MES so >2 firms
Autarky and the Choices based on Alt. Theory 3 (Cost vs. Variety)
More variety=more firms= increase MES (cost / unit) =increase price people would have to pay
***Choice depends on preference of country
International trade and the Choices based on Alt. Theory 3 (What does international trade do?)
-It opens set of CHOICES for people in each country with each type produced at its MES in every country
Observations of the move from AUTARKY to FREE TRADE
-Whatever each country chooses, the tradeoff between variety and cost has improved with international trade (gain from this model)
-More variety without paying a higher price
In General what happens when the MES of typical firm is large relative to DOMESTIC market?
-Having more choices is EXPENSIVE when NOT trading
-Having more choices is CHEAPER when TRADE
Does trade cause any change in a firm's production? Instead what does trade offer with alt. theory 3?
-International trade does NOT necessarily cause any change in any firm's production
-It only means ppl can start to buy different types of the product that like from other countries (choice is not limited)
Conclusions about Alt. Theory 3
1. Explains RICH:RICH trade and INTRA-INDUSTRY trade among rich countries
2. GAIN from trade comes from VARIETY (not Comparative advantage)
3. No reason to expect Stolper Samuelson theorem to apply b/c no change in total demand for HSL or LSL to change so no impact on income
Further Gains from Trade with Alt. Theory #3
-Transforms market structure to one more favorable to consumers
How does trade makes the market structure more favorable to consumers?
1. Trade opens= competition rise= price fall so price brings closer to cost per unit= benefit consumer
2. More competitive= Trade FORCES fights in all countries to produce higher QUALITY products + INNOVATE = benefit consumer
What Transportation costs can help explains?
1. Expansion of International Trade
2. Rise of Supply Chains
3. Trade patterns for high-transportation cost goods
Expansion of International Trade 1950s- present
3 revolutionary changes in world that LOWERED transportation cost
3 revolutionary changes to expand int. trade
1. 1950s: Shipping containers
2. 1980s: Miniaturization
3. 2000: Digitalization
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