Question

Consider the pharmaceutical sector in the UK, populated by heterogeneous firms, which differ in labour productivity, produce subject to increasing returns to scale, and sell under monopolistic competition. Serving the domestic market entails a fixed cost, fD​, while exporting to France entails a variable cost τ>1 and a fixed cost fX​>fD​. Suppose that an increase in auditing costs drives the fixed cost of serving the British market up to fD′​=fX​. Then:

(a) British exporters will make larger profits both in the UK and in France, while small British firms only selling in the UK will sell less and make lower profits
(b) British exporters will make the'same profits as before both in the UK and in France, while small British firms only selling in the UK will sell as much as before but make lower profits
(c) the profits of British exporters will increase in the UK and remain constant in France, while small British firms only selling in the UK will sell less and make lower profits
(d) none of the above

Answer 1

If the fixed cost of serving the domestic UK market increases to the same level as the fixed cost of exporting, it's likely that British exporters will see increased profits domestically while maintaining constant profits in France. Small British firms that do not export will likely face lower sales and profits due to the higher costs. Therefore, option (c) seems most probable.

Step-by-step explanation:

In this scenario, we are considering the pharmaceutical sector in the UK with firms producing under monopolistic competition and facing increasing returns to scale. Initially, these firms face different fixed costs for serving the domestic market (fD) and exporting (fX), with the latter being higher. An increase in auditing costs that equalizes the fixed cost of serving the domestic market with that of exporting would bring different outcomes for British exporters and smaller domestic firms.

For British exporters that are already incurring the high fixed costs associated with exporting, this change could level the playing field within the domestic market, potentially allowing them to allocate resources more efficiently and compete more effectively against firms that do not export. The result could be higher domestic profits due to increased market share or pricing power, but export profits would not necessarily change, as the cost structure for exporting remains the same. However, for small British firms that only serve the UK market, an increase in fixed costs squeezes their profit margins. Without the economies of scale that larger exporters have, these firms are likely to see reduced sales and lower profits as they struggle with higher costs.

Overall, the scenario suggests that multinational pharmaceutical firms may potentially benefit from the equalization of fixed costs, whereas smaller firms focusing solely on the domestic market may suffer financially. Based on this analysis, option (c) 'the profits of British exporters will increase in the UK and remain constant in France, while small British firms only selling in the UK will sell less and make lower profits' appears to be the most likely outcome.