This question deals with internal economies of scale, when firms are not all identical and there...

This question deals with internal economies of scale, when firms are not all identical and there is an option to engage in horizontal foreign direct investment (FDI). This entails paying some fixed cost (F) to set up a plant in a foreign country. Setting up a plant means that firms do not have to pay the per unit export cost (t) when selling units of output to the foreign country. You can think of firms as differing in terms of their total foreign sales Q, which is fixed per firm.

What types of firms will decide to set up an FDI plant? You do not need to draw a diagram, but a little algebra would be helpful in explaining your response.
Suppose the fixed cost of setting up an FDI plant (F) increases. What would happen to the types of firms that would want to set up an FDI plant and the types of firms that want to export, in terms of each firm’s total foreign sales Q? (i.e. are firms with higher/lower Q more or less likely to set up FDI, and are firms with higher/lower Q more or less likely to export instead of FDI?) You may assume that each firm’s Q stays constant before and after the change in F.

Expert Solution

Rahul Sunny answered 1 year ago

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