Question

Giocattolo is a profit-maximizing firm producing toy cars-a capital-intensive good-which are sold in its home country, Italy, and abroad in Spain. Giocattolo chose foreign production as a method of penetrating the Spanish market and has to decide whether it is more efficient to directly invest in Spain to establish a production subsidiary or to license the technology to a Spanish firm to produce its goods. On the following graph, AVC pis is the average variable cost curve of a Spanish firm producing toy cars. (This curve represents costs such as labor and materials.) The curve ATC Subsidiary represents the total unit costs Giocattolo will face if it establishes a subsidiary in Spain. 10T ATC subsidiary PER-UNIT COST (Dollars) 0 10 20 30 40 50 60 70 PRODUCT (Thousands) 80 90 100

Answer 1

Question

ATC_subsidiary is the total unit cost of Glocattolo when it establishes subsidiary in Spain.

AVC_Spain is the average variable cost when manufacturing is licensed to a Spanish firm.

The given figure shows that ATC_subsidiary and AVC_Spain are intersecting each other corresponding to output of 40,000 toy cars.

Before the output of 40,000 toy cars, ATC_subsidiary > AVC_Spain.

So, production of output below 40,000 toy cars would be economical through licensing to a Spanish firm.

If Glocattolo estimates the demand for toy cars in Spain as 35,000 toys per year then,

Glocattolo's best strategy is to license production to a Spanish firm.

If Glocattolo can acquire capital at lower cost than Spanish firm then average total cost of production of Glocattolo in Spain through its subsidiary will decrease.

Due to this,

The decision to form a subsidiary instead of licensing will occur at a lower level of output.