Significance of imperfect competition models for explaining the pattern of international trade - Essay Example

? Significance of imperfect competition models for explaining the pattern of international trade Introduction International trade is growing day by day as a result of globalization and liberalization policies implemented by different countries at different parts of the world. The major obstacles for the smooth flow of goods and commodities between different countries have been diminished a lot as a result of globalization. At the same time one of the major problems associated with international trade is the fact that the problems happened in one part of the world can have detrimental effect in other parts of the world as well. “Political change in Asia, for example, could result in an increase in the cost of labor, thereby increasing the manufacturing costs for an American sneaker company based in Malaysia” (What Is International Trade?, 2003). Competition is growing immensely in the market as a result of the rapid growth of international trade. Ideally, all organizations would like to have some kind of monopoly or some kind of control over the price mechanisms in the market. However, growing competition prevent organizations from controlling the market effectively. Competition in the market can be labelled as perfect competition and imperfect competition. Perfectly competitive markets refer to the markets in which the firms do not possess any market power whereas in imperfectly competitive markets, some organizations definitely have control in the market as far as price mechanisms are concerned. “Competitive markets provide strong incentives for good performance - encouraging firms to improve productivity, to reduce prices and to innovate; whilst rewarding consumers with lower prices, higher quality, and wider choice” (Riley, 2006) whereas imperfect competition denies all these things. “If a firm does not take the price level on the market as given, but strategically interacts with other firms and the market to maximize its profits, we say such a market is characterized by ‘imperfect competition’”(Competitive advantage, 2009, p.181). Both perfect as well as imperfect competition has significant effects on international trade. “The hottest topic in international trade theory during the 1980s was undoubtedly imperfect competition”(Pomphret, 1992, p.1).This paper analyses the significance of imperfect competition in the market as far as international trade is concerned. International trade and imperfect competition “Imperfect Competition exists when more than one seller competes for sales with other sellers of similar products, each of which has some control over price” (Models of Imperfect Competition, n. d, p.1). In other words, in an imperfectly competitive market, firms may have some power in the market as far the fixing of the prices of its commodities is concerned. Monopoly or oligopoly exists in such markets. For example, Microsoft enjoys monopoly in operating system market. They are capable of fixing the prices of their operating systems like Windows 7 in global market because of lack of competition. Even though Linux and Apple’s Macintosh operating system are raising some kind of competition, still Microsoft is able to maintain their monopoly in the imperfectly competitive operating system market. Same way, OPEC countries are enjoying oligopoly in the oil market. It should be noted that monopolies or imperfect competition helped Microsoft and OPEC to dictate the market with the help of least efficient products. Consumers forced to pay more than the actual prices of a product in an imperfectly competitive market. In short, “Firms in a competitive market have very little control over what price they receive for their output”(Perfect Competition, n.d.) whereas “Monopolies have the most market power, which yields the least efficient outcome” (Monopoly and Perfect Competition Compared, n.d., p.4) According to Krugman et al (2011) “In a competitive economy, supply decisions are determined by attempts of individuals to maximize their earnings” (Krugman et al, 2011, p.27). For example, OPEC countries are producing more oil when the demand goes high and they will reduce the production when the demand comes down. In other words, OPEC countries are adjusting the supply based on the demand of oil in the market in order to limit price fluctuations in the market. The following graph illustrates price theory in a market. (Price Theory, n.d., p.2) When perfect competition exists, price becomes equivalent to marginal cost (P=MC). On the other hand in an imperfectly competitive market, monopoly causes increase in price. “Prices of internationally traded goods, like other prices, are determined by supply and demand” (Krugman et al, 2011, p.29). Nokia was the leader in the mobile phone market until recent times. However, the introduction of smart phones or touch screen phones by Apple and Samsung caused major challenges to Nokia in maintaining supremacy in the market. Apple and Samsung were able to realize the demand for smart phones in the market much earlier than other competitors. They have captured the smart phone market with the help of products such as iPhone and galaxy. However, it should be noted that mobile phone market is a perfectly competitive market in which no firms can claim any kind of supremacy now. Majority of the major mobile phone manufacturers have already entered the smart phone and tablet market and therefore no firms are capable of claiming any supremacy in this market at present. The concept of free trade is another entity which has significant influence in an imperfectly competitive market. “The act of opening up economies is known as "free trade" or "trade liberalisation”" (What is free trade?, 2012). Free trade between different countries has been increased a lot in the past few decades as a result of globalization. In fact countries are currently competing each other to encourage free trade because of the awareness about the importance of free trade in boosting economic growth. Even communist China is ready to open their economy more widely to encourage free trade. Different regional trade blocs such as EU, ASEAN etc were formed at different parts of the world in order to increase the free trade activities between countries. Some people argue that productivity of a country should be considered seriously while encouraging free trade. In other words, free trade is not a good concept for non-productive countries. However, Krugman et al (2011) rejected all such claims and argued that “The competitive advantage of an industry is dependent not only to its productivity relative to its foreign industry, but also the domestic wage rate relative to the foreign wage rate” (Krugman et al, 2011, p.37). Julian, (2010) also supported the ideas of Krugman et al. In his opinion, “the degree of market power does not only depend on the fundamentals or on the number of agents, but also on the way agents form their conjectures in strategic interactions” (Julian, 2010, p.662). David Ricardo (1817) introduced standard trade theory (comparative advantage theory) in which he postulated that goods are mobile across international boundaries than resources such as land labour and capital. This assumption is the core of intra industry trade theory (Ruffin, 1999, p.2). According to Krugman et al (2011) “Intra industry trade produces extra gains from comparative advantage because intra industry trade allows countries to benefit from larger markets”(Krugman et al, 2011, p.129). It should be noted that intra industry trade allows countries to access bigger international markets. The opportunities in bigger markets could be more than that in domestic markets. In other words, a country can sell more goods in international markets than in domestic markets while it engages in intra industry trade. Dumping is the business strategy which helps firms to exploit international markets smartly with the help of intra industry trade. “Dumping is a process in which firms charges lower prices to exported goods than it does for the same goods sold domestically. Dumping occurs only when the industry is imperfectly competitive and market is segmented” (Krugman et al, 2011, p.130). The business strategies in international market and that in domestic market are entirely different as far as a business organization is concerned. A firm will give more importance to international market than domestic market because of the higher values and strengths of foreign money compared to the domestic money. Moreover, a firm can sell more goods in international market than in domestic market and therefore lower unit prices in international market may not affect the firm very much. For example suppose a firm sell a particular product (Actual cost equal to $ 8) for $10 in international market and $ 15 in domestic market. Suppose the firm is able to sell 100 units in domestic market and 1000 units in international market. In this case, the profit from domestic market would be $ 700 whereas that from international market would be $ 2000. In other words, even if the firm sells the product at a much cheaper rate in international market, it can still earn more profit with the help of larger selling. It should be noted that competition in domestic market and that in international market could be entirely different. “In reality, imperfect competition helped firms to charge different prices for the goods that exported and those that are sold to the domestic buyers” (Krugman et al, 2011, p.131). (Krugman et al, 2011, p.122) “The situation in which dumping leads to two way trade in the same product is known as reciprocal dumping” (Krugman et al, 2011, p.135). For example, American automobile manufacturers might be shipping cars to Japan while Japanese car makers doing the reverse. The thirst for foreign goods quiet often force people to purchase a foreign good even if same good with better quality is domestically available. For example Americans like to purchase Toyota or Honda cars even if they have access to better quality American cars. Reciprocal dumping helps firms immensely in selling goods in international market. “In the comparative advantage models, trade is essentially inter-industry trade. Developed countries export products from capital-intensive industries (computers, machines), while importing products from labor-intensive industries (textiles, agricultural products)” (Economies of Scale, Imperfect Competition and International Trade, n.d., p.2). For example, productivity of India is lesser than that of America. However, manpower cost in India is extremely smaller than that in America. Currently American companies are saving billions of dollars yearly as a result of outsourcing to India. In short, even though the productivity of India is comparatively lesser than that in America, they are still able to maintain a good growth rate because of their ability to earn revenue from industries such as outsourcing. According to d’Onofrio & Wigniolle (2010), “Firms with the lowest productivity are competitive as their technology is freely available” (d’Onofrio & Wigniolle, 2010, p.355) Most heavily populated countries like China and India are developing much rapidly than other countries. In fact India and China taught others a lesson; they have shown that how can a curse be transformed into a blessing. If India concentrated mainly in utilizing its manpower resources in outsourcing like industries, China did succeed in utilizing its huge manpower resources for bulk production of goods. In fact Chinese products are currently enjoying a kind of monopoly in international market because of its cheaper price. In other words, Chinese products transformed many of the perfectly competitive markets into imperfectly competitive market. For example, Chinese toys are so popular in international market because of better technology and cheaper prices. “The higher cost of production and the smaller output under imperfect competition will cause the volume of trade will also be smaller than it would be under perfect competition” (The quarterly journal of economics, 1941, p.567). Exchange rate is another term usually associated with international trade. “The exchange rate is the price of domestic assets, (primarily, domestic money, bonds & equities) in terms of foreign assets (equivalent foreign assets in foreign currency)” (exchange rate- please provide correct citation). Exchange rate between two countries depends on the economic growth in those countries. For example, if India develops more rapidly than America, US dollar value against Indian rupee may come down. On the other hand, if US develop more rapidly than India, dollar value against Indian rupee may increase. When inflation occurs beyond certain limits, countries often increase the interest rates in order to control the prices of commodities in the market. “An increase in the domestic real interest rate increases the demand for domestic assets and causes the domestic currency to appreciate. An increase in the foreign real interest rate decreases the demand for domestic assets and causes the domestic currency to depreciate” (exchange rate- please provide correct citation). Interest rate increase in foreign countries may not be a good sign for domestic country as more people may try to invest in foreign currency than in domestic currency. For example, appreciation of dollar and increase in interest rates in America may force investors all over the world to select dollar as safe deposit option. Infant industry is defined as an industry relatively new in a market. It is the duty of the governments to protect infant industries with the help of adjustments in tariffs and subsidies. In other words, governments may enforce less tariffs and more subsidies to infant industries to increase its competitive power in the market. It is impossible for an infant unit to survive in a market in which international players are active. It should be noted that small scale industries are economic backbones of a country. These small scale industries may not be developed properly if the government allows international companies to participate in the market with less trade barriers. So, government may enforce larger trade barriers to international companies and lesser trade barriers to domestic companies. Strategic Trade Policy or STP is defined as trade policy which alters a strategic relationship between firms. For example, Wal-Mart has established an alliance with an Indian company as part of their mode of entry to Indian market. Wal-Mart can easily penetrate any international markets because of their larger market share and resources. However, they decided to establish collaboration with an Indian company as a strategic trade policy. Conclusions Imperfect competition is one of the rarest market phenomena as far as international trade is concerned. Only few organizations are currently enjoying monopoly or oligopoly in the market now. Imperfect competition is against the norms of globalization and the interests of consumers. It helps companies to control the prices of products and services in the market. It may help some companies or countries to accumulate wealth at the expense of others. On the other hand, in a perfectly competitive market, consumers may get more bargaining power because of the competition between different firms. Since the economic growth of a country depends on the ability of that country to accumulate foreign money, all countries like to expand their international trade as much as possible. In fact companies and countries will fix the prices of their exporting goods lesser than the prices of same goods in the domestic market as a strategy to capture as much as foreign money possible. Exchange rate and inflation rates can affect international trade immensely. The currency value of a particular country depends on the economic growth of that country. Currency value increases when economy increases and it decreases when economy declines. Same way, higher inflation rates result in increase in interest rates which will attract more investments domestic market. At the same time, interest rate increase may adversely affect the growth of business. In short, imperfect competition is better than perfect competition as far as the positive aspects of international trade to a country is concerned. Profits from perfect competitive markets are lesser than that from imperfect competitive market. References 1. Competitive advantage, 2009, [Online] Available at: http://www.oup.com/uk/orc/bin/9780199280988/marrewijk_chap09.pdf [Accessed on 30 January 2012] 2. d’Onofrio B & Wigniolle B. 2010, Imperfect competition, technical progress and capital Accumulation International Journal of Economic Theory doi: 10.1111/j.1742-7363.2010.00140.x 3. exchange rate- please provide correct citation. 4. Economies of Scale, Imperfect Competition and International Trade, (n.d.). [Online] Available at: http://www.econ.ucdavis.edu/faculty/asschea/ECON162/notes/Chapter6.pdf [Accessed on 30 January 2012] 5. Julian L.A. 2010. From imperfect to perfect competition: A parametric approach through Conjectural variations. The Manchester School Vol 78 No. 6 660–677 December 2010 doi: 10.1111/j.1467-9957.2009.02167.x 6. Krugman P R, Obstfeld M & Melitz M. 2011. International economics. Chapter 3, Labour productivity and comparative advantage. Publisher: Prentice Hall; 9 edition ( 7. Monopoly and Perfect Competition Compared, n.d. [Online] Available at: http://courses.missouristate.edu/ReedOlsen/courses/eco165/Notes/pc-m.pdf [Accessed on 30 January 2012] 8. Models of Imperfect Competition, n. d. [Online] Available at: http://homepages.wmich.edu/~mryan/E201/Notes/ImperfectCompetition.pdf http://courses.missouristate.edu/ReedOlsen/courses/eco165/Notes/pc-m.pdf Pomphret R. 1992. International trade theory with imperfect competition. [Online] Available at: http://www.princeton.edu/~ies/IES_Special_Papers/SP17.pdf [Accessed on 30 January 2012] 9. Price Theory, (n.d.). [Online] Available at: http://www.csun.edu/~dgw61315/PTlect7y.pdf [Accessed on 30 January 2012] 10. Perfect Competition, n.d. [Online] Available at: http://classnotes.aaec.vt.edu/aaec1005/coursematerials/MarketExamples/perfect_competition.htm [Accessed on 30 January 2012] 11. Riley G. 2006. Perfect competition. [Online] Available at: hhttp://tutor2u.net/economics/revision-notes/a2-micro-perfect-competition.html [Accessed on 30 January 2012] 12. Ruffin, R.J. 1999. The nature and significance of intra industry trade. Economics and financial review. Fourth quarter 1999. 13. The quarterly journal of economics, 1941, Vol. 55, No. 4, Aug., 1941. [Online] Available at: http://www.jstor.org/pss/1884118 14. What Is International Trade? 2003. [Online] Available at: http://www.investopedia.com/articles/03/112503.asp#axzz1kuZQtS1P [Accessed on 30 January 2012] Read More