What do we mean by “Globalization”? Essay

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03/11/2013

Business in the Global Environment
Dr. Veronica Rappoport
Lecture 5

Topics Covered in this Course
1. Is the world flat?
2. Long-term trends
3. Business practices across countries
4. Global strategies:
- International trade
- Foreign direct investment

5. International capital flows
6. Global imbalances and the Great Recession

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Recall last class
• Under free trade countries have an incentive to specialize in their comparative advantage sector
– Home has an incentive to specialize in Grain
– Foreign has an incentive to specialize in Cloth

• Intuition: Specializing according to comparative advantage makes each country better off
– They can import their comparative disadvantage good for a lower price than they can make it themselves
– How do we quantify “better off” in the model?
3

Recall last class
Cloth

Home

Cloth

Foreign

PG/PC= 2/3
PG/PC= 2/3
PG= 1/2

P G= 1

Grain

• Full specialization: Home produces G and Foreign produces C
• Consumption and Production differ (C ≠ Y)
• Slope given by international price

Grain

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Perfect Competition and Homogeneous Goods
• Very few markets resemble this ideal
– Firms produce an homogenous variety of Clothes
• Their production is perfectly substitutable

– Firms are small
• They take the price of their product as given and choose how much to produce
• They can increase supply without affecting world prices
• Firms produce until Marginal Cost is equal to Price

• Typically this is not the case
– The decision of how much to produce and at what price are interconnected.

5

Today: Global Strategies
• Differentiated vs. Homogenous Goods
– Tool: Optimal pricing decision
– Application: Problem Set 3

• Debate: Wine Exports in Argentina
– From an homogenous to a differentiated product

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Differentiated Goods
• Markets are typically neither pure monopolies nor perfect competition
– Small firms producing differentiated goods.
Markups depend on:
• How close are alternative substitutes?
• How connected are prices and quantities?

– For large firms, markups also depend on:
• Market share

7

Math Tool: Derivatives
• Some useful derivative rules: f(x) a ax +b axb g(x) + f(x) ag(x) + bf(x) g(x) f(x)

f’(x)

Comment a is a number a and b are numbers a and b are numbers

0 a baxb-1 g’(x) + f’(x) ag’(x) + bf’(x) a and b are numbers g’(x) f(x) + g(x) f’(x)

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Price and Quantity Decisions
Profits = P Q – C
Revenues

Cost

– If +1 unit implies that Extra Rev > Extra Cost à rise Q
– If +1 unit implies that Extra Rev < Extra Cost à lower Q
– Optimum: Extra Revenue = Extra Cost

• Taking Derivatives:
– Mg Cost: extra cost of increasing Q infinitesimally
Cost = F + c Q à Mg Cost = c
– Mg Revenue: extra revenue of increasing Q infinitesimally
Rev = P Q à Mg Rev = P’ Q + P
• P’: Change in P when Q increases infinitesimally
• P’ = 0 in perfect competition

9

Price and Quantities in Monopolistic Competition

P(Q): Demand face by each firm
Consumers will pay higher price if quantity is lower P(Q)

That is: P is downward sloping. Mathematically: P’ MgCost
Can get extra profit by increasing Q

PO
MgCost

P(Q)

MgRev < MgCost
Can reduce losses by lowering Q

MgRev

QO

Q
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Equivalent Approach
• Choose Q to maximize profits
– Derivative of profits with respect to Q equals 0
Prof(Q)

d Prof = d Rev – d Cost = 0 dQ dQ dQ MgRev MgCost

Mg Rev > Mg Cost

Mg Rev < Mg Cost

QO

Q

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Example
• N firms producing differentiated goods in a given industry. – Demand of one firm decreases with own price (P), relative to the average price of similar products (P*): P – P*
– No fixed cost. Firm’s unit cost of
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