*Please label the part of the question you are answering. Trade Dispute: You are
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Question
*Please label the part of the question you are answering.
Trade Dispute: You are a research associate covering the solar panel industry for Goldman Sachs. The countries of Transylvania and Oceania are having a trade dispute. Upset with behavior of Transylvanian firms, the government of Oceania is threatening to close its market to Transylvanian firms. You are asked to write a research report on the implications of this scenario.
Some information about the solar panel industry in the Oceania and Transylvania:
• Firms in both countries share the same technological characteristics. Consultants from Accenture report that the fixed cost associated with producing a solar panel are $50,000, the variable costs associated with producing a solar panel are $25. The demand elasticity parameter ”b” was estimated to be 1/50.
• Your analyst reports industry characteristics of the Oceania and Transylvania market: Currently there are 10 firms in the combined market. Three of these firms are located in Oceania. The other seven firms are from Transylvania.
• Total solar panel demand (and units sold) in the combined market is 100,000 units. Out of the total, 25,000 units were sold in Oceania and 75,000 units were sold in Transylvania.
a. A colleague argues that closing the Oceania market to foreign competition is good for the firms currently operating in Oceania—in the long run—because it will “return pricing power” to firms and, hence, each individual firm’s revenues (price times quantity sold) will increase relative to the current situation (i.e. the combined market). Is your colleague correct? Please explain why or why not.
b. Your managing director suggests that you speculate on the following issue: if firms differ in their efficiency, how will average industry productivity change (if at all) in the Oceania market as it closes to foreign competition. Please do so below.
Explanation / Answer
a. It is clear from the information provided that the market for solar panels in Oceania is just a fraction of the market for same in Transylvania. Closing down foreign competition in Oceania would not affect the Transylvanian firms to a great extent since they have a huge market to supply in their own country. Also, since that out of the total firms available for supplying solar panels, majority of them are located in Transylvania.
A closed economy is likely to benefit the domestic firms and thus returns the pricing power in the hands of the three firms supplying solar panels in Oceania. The firms will be able to improve their revenues through a shut down of foreign competition but the long run effects will have no innovation and low pricing strategy and might further spur the prices through cartels or an oligopolistic market structure.
b. Competition is a major factor that decides the growth of industries in any region. Competition is said to spur innovation and competitive measures by the industry in order to capture a larger market share. Thus, the productivity and costs are likely to be on a higher end when foreign competition is shut down.
The market for solar panels in Oceania can well be covered effectively by the three firms that the country posses, but closing foreign exposure can hamper the competitiveness and innovation to produce and provide solar energy at lesser costs and through new mechanisms. A low price offered by Transylvanian firms acts as a driving factor to engage in effective innovation to reduce costs in Oceanian firms.
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