Question

Explain the proximity-concentration tradeoff in the context of horizontal foreign direct investment (FDI). If fixed cost amounts to $175,000,000 and per unit trade cost is equal to $250, determine the scale cutoff for output.

Answer 1

Answer 2

In the context of horizontal foreign direct investment (FDI), the proximity-concentration tradeoff refers to the balance between locating production closer to the target market (proximity) and consolidating production in a single location (concentration). This tradeoff arises when a multinational company decides whether to set up multiple production facilities in different countries or concentrate production in one location and export to other markets.

The proximity aspect suggests that locating production closer to the target market can offer advantages such as reduced transportation costs, quicker response to market demands, and better understanding of local consumer preferences. On the other hand, concentration offers economies of scale, cost efficiencies, and the ability to leverage specialized resources or infrastructure in a single location.

Now, to determine the scale cutoff for output, we need to consider the fixed cost and per unit trade cost.

Fixed cost: $175,000,000 Per unit trade cost: $250

The scale cutoff for output is the point at which the cost of producing an additional unit domestically (including fixed costs and per unit trade costs) becomes equal to the cost of producing the same unit in a foreign location and exporting it to the target market.

Let's denote the scale cutoff as Q, where Q is the quantity of output. At the scale cutoff, the cost of domestic production (including fixed costs) would be equal to the cost of foreign production plus trade costs.

Cost of domestic production = Fixed cost + (Q * 0) [assuming there are no variable costs in this simplified scenario]

Cost of foreign production + trade costs = (Q * $250)

Equating the two costs:

Fixed cost + (Q * 0) = (Q * $250)

Simplifying the equation:

Fixed cost = Q * $250

$175,000,000 = Q * $250

Q = $175,000,000 / $250

Q = 700,000 units

Therefore, the scale cutoff for output is 700,000 units. If the quantity of output is below this threshold, it would be more cost-effective to produce domestically. If the quantity exceeds this threshold, it would be more cost-effective to produce in a foreign location and export to the target market, considering the fixed costs and per unit trade costs provided.