PART A

1. Explain how differences in pre-trade relative prices serve to create specialization in producing one good or the other in each of two countries; and, explain how this process serves to raise real income (consumption) in both countries.

2. Explain the standard model of so-called "perfect" competition; in particular the typically-assumed shape of the market demand and supply curves in relation to the average- and marginal-cost curves facing an individual firm. Contrast this with the phenomenon of oligopoly, including the several competitive strategies discussed in class.

PART B

3. Discuss the nature and significance of the following elements in the decision to multinationalize "horizontally" (i.e. HDFI)

a) Price elasticities of demand
b) "Trade" costs and market shares
c) Short-run production ("operating") costs
d) Fixed costs - both "plant" and "headquarter/administration" costs
e) "OLI" - non-quantifiable - considerations

PART C

Intro: You have been hired as a "Business Development Analyst" by a firm that makes 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 firm 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 $100M. 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 1 0% 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.

4. In order to establish production in RoW your firm would need to build a new $10M 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 $1/2M for the next ten, and $1M per year thereafter. Your current facilities in the US are ten years old, for which the firm borrowed $15M - $8M for the plant and $7M for "start-up"/"headquarter" 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?

5. 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 production in both countries has always been "integrated", at the current (ostensibly "normal") exchange rate, the process actually breaks down fairly neatly into component manufacture and subsequent assembly. In fact, he has just received comparative costs as follows (using the notation of Ch 4 in N&V):

US: $200 = $140 (cl ) + $60 (a1)
RoW: $225 = $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 the 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 byzantine. 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 levied 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 tariff on 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?

6. Assume the following values:

c1=60 (component manufacturing cost per unit in country '1')
a1=100 (assembly cost per unit in country '1')
c2=100; and a2=-80.(E6Sts in country '2' as given for '1')
ta=trade cost ratio for assembled (final) good (i.e. ta=1 means no tariffs/subsidies or shipping costs)
tc=trade cost ratio for components (the "unfinished" or "intermediate" good)

1. a) If the manufacturing process can be split into two stages ("disintegration"), what would happen if there were no trade costs (i.e. ta = tc = 1).

b) If instead, manufacture could NOT be split:

i) what would happen if there were no trade costs?
ii) at what value of 'ta' would there be no trade at all?

2. a) Given 'ta' as determined in the last question (1b(iii)):

i) at what value of 'tc' would country '2' be supplied with units assembled in country '2'?
ii) if ta=1, what would your answer for the value of 'tc' be?

b) Given tc=1, at what value of 'ta' would country '1' be supplied with units assembled in country '2'?

c) Try different values of 'tc' and graph them against the resultant values of 'ta' that would cause all assembly to occur in country '2' - what would values for 'ta' and 'tc'-less than one mean?