978-0132146654 Chapter 8 Solution Manual

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n Answers to Textbook Problems

1. With internal economies of scale, there is imperfect competition and firms set marginal revenue equal

to marginal cost. Unlike the case of perfectly competitive markets, under monopoly marginal revenue

2. To solve this problem, we need to first find the equilibrium number of firms in the three country

integrated market by setting average cost equal to price across all markets. We do this by first noting

that average cost can be written as AC  (nF/S)  c and price can be written as P  c  (1/bn), where

n is the number of firms, F is the fixed cost, S is the market size, c is the marginal cost, and b is a

constant. Setting the average cost equal to price yields the following expression:

(nF/S)  c  c  (1/bn)

n2  (1/b)  S/F

n  [(1/b)  S/F]

1/2

The numerical problem in the chapter gives us the following values:

F  750,000

SHome  900,000, SForeign  1,600,000, SCountry 3  3,750,000

c  5,000

b  1/30,000

Note that the fixed cost F is stated in the text to be 750,000,000, but if you look at the solutions

presented in Figure 8-5, you will see that F must equal 750,000. Finally, compute the total market

size as the sum of the market sizes in Home, Foreign, and Country 3:

a. The condition we derived in Problem 2 was n  [(1/b)  S/F]. Looking at the Price equation above,

we see that 1/b  150. Plug in the relevant parameters to solve for the equilibrium number of

firms in the United States and the European Union:

Chapter 8 Firms in the Global Economy: Export Decisions, Outsourcing, and Multinational Enterprises 36

b. Without trade, there will be different prices in Europe and the United States:

c. After trade, the new market size is S  300,000,000  533,000,000  833,000,000

Simply plug this new market size into the equilibrium number of firms expression from part (a):

d. U.S. prices are lower in part (c) because of internal economies of scale. After trade, total world

automobile production is produced by only 5 firms as compared to 7 firms before trade (3 in the

4. a. We can model this decision by defining the technology in the following terms: If a firm invests in

the technology, it will face a fixed cost T, but face a marginal cost cT which is lower than its

marginal cost c without the technology. Thus, we define the firm’s total cost with and without

the technology as:

As with most decisions involving fixed costs, the technology is more likely to increase a firm’s

profits when the scale of production increases.

Now compare a firm with low marginal costs and one with high marginal costs. The gap c  cT

b. Trade costs raise the marginal cost of exporting. A firm that exports faces a higher marginal cost

5. a. We know that the number of firms competing in a market increases as the

size of the market rises. At the same time, the price charged in a market falls as the number of

b. A firm exporting from a small country to a large country will experience a larger difference

between its domestic price (higher) and its export price (lower) since there will be more firms

6. a. $10 million of IBM stock is nowhere near 10 percent of the total market value of IBM. Thus, this

is not considered Foreign Direct Investment.

Chapter 8 Firms in the Global Economy: Export Decisions, Outsourcing, and Multinational Enterprises 37

b. A New York apartment building is considered an asset, so its purchase (100 percent ownership)

c. This merger would represent more than 10 percent ownership of the American company by the

d. If the Italian firm retains ownership of the plant in Russia, then this is Foreign Direct Investment.

7. a. This would be a horizontal FDI outflow from the United States and a horizontal FDI inflow

8. Even with internal economies of scale, there may still be an advantage to producing the same good

9. This question relates to the decision by a multinational to outsource production or to engage in direct

10. Intrafirm trade will be higher in industries with a high degree of vertical FDI. As capital-intensive