1. The two key characteristics of MNEs are that instead of exploiting foreign markets via trade they set up parallel production and distribution operations in the Foreign country; and. they are typically far from our conception of "perfect" competition, being instead "oligopolistic". Explain why, from a national point of view, trade is profitable; and why, from a company's point of view, "imperfect" competition Is profitable.
2. You have been hired as a "Business Development Analyst" by a firm that nukes an "all-purpose" handyman tool-kit for around-the-house type jobs. The average cost of producing a unit is constant at $200, it sells in country 1 (US) for $250, and your firm is one of four that equally share the total US market of $60M. Your Firn is also the only one of the four US producers to export the product to country 2, (RoW), where there are three existing (foreign) companies. each with a 30% share of a total market (sales revenue) of $100 M. The (constant) unit cost of producing a unit in RoW'" is $225, and the price charged by the three foreign producers is $270. However, due to "trade costs" -a 10% transport cost and a 10% tariff imposed by country' 2. both by value - the US product sells in RoW for $300 -hence the significant reduction in market share - which therefore yields a net price of $250, the same as in the US.
ln order to establish production in RoW your firm would need to build a nets $1074 dollar plant there. with long-term (say, 30-year, the working life of the plant) finance currently available at 15%. No significant maintenance costs would obtain in the first ten years, rising to $1/2 M for the next ten, and $ 1 M per year thereafter. Your current facilities in the US arc ten years old, for which the firm borrowed $ 15 M (UM for the plant and $7 M for '"stars-up"rheadquarter" costs) at a rate of 10% (also over 30 years). In addition to this interest cost these facilities have maintenance and staffing "fixed" costs of $ 1M a year. What would you advise the company to do, and why?
3. While the Board is mulling over the material you have provided for them to make a decision, the CEO has come up with another angle that s/he would like you to look into asap. Namely, although procluctior in both countries has always been -integrated". at the cunent (ostensibly "normal") exchange rate, the process actually breaks down fairly neatly into component manufacture and subsequent assembly.
In fact, s/he has just received comparative costs as follows (using the notation of Gli 4 in NikV):
US: $200 = $140 (cl) + $60 (al)
RoW: $223 - $180 (c2) $45 (a2)
The CEO's feeling is that in addition to the revenue argument on which the original interest was based, there may be lower costs obtainable by vertical disintegration. If so, this would depend upon whether th trade costs of shipping components were significant. Unfortunately, the company lawyer is having difficulty in determining what, if any. tariffs might apply to components since it has never been done in practice and trade law is incredibly Assuming: a) that the trade costs of shipping the final good are the same in both directions (i.e. 20% - 10% for transport and a 10% tariff in US levled on RoW product, although this has never been applied since the US has not been importing the final good from the ROW); and b) that the pure transport cost of components would be 5% of value, what levels of riffon the component would make it profitable to
(i) Assemble the product in the country in which it is sold; or
(ii) Assemble the product entirely in RoW?
4. While you are working on this problem, the company economist comes up with another possible angle. SIw points out that under the theory of "effective" tariff rates, if the tariff on components in one country is higher than in the other, that would bias production toward the country with the lower rate, so maybe the company should fire you and just hire a lobbyist to persuade the VS (and RoW) legislatures to raise or lower their rates, In order to keep your job, explain this theory and see if you can verify it in terms of the previous question's deduced rates.
5. The HFDI and VFDI models discussed in questions (2) and (3) above focus on given, known production and "trade" costs as the key variables in making a decision to multinationalize, However, there may also be other, less precise but equally important elements that should be considered: specifically, the internalization" aspect of Dunning's general "OLI" approach to evaluating the pros and cons of multinationalization; and the even more general issue of risk vs, return as manifested in "diversification" on economic activities. Discuss both of these aspects.