ECON1269 international trade prisoner’s dilemma with the existence of oligopoly

Group Assignment 2
ECON1269 International Trade

Member name

Vu Hien Linh - s3756735
Le Minh Hoang Minh - s3748986
Do Nhu Nguyen - s3671998
Dao Thanh Hung - s3751828

Lecturer name

Phan Minh Hoa

Class

Wednesday morning

Campus

Hanoi RMIT campus

Word Count

1995 (excluding references, titles
and figure’s name)


Question 1:
1. Prisoner’s Dilemma with the Existence of Oligopoly:
Prisoner’s Dilemma is a game theory where two players, based on their predictions on how the

other will play, would make a response for it. There are 2 choices for both, Defect and
Cooperate, so there will be 4 outcomes, creating a matrix below. The best scenario for both is to
coop, but there would be a risk since one player could cheat and get the highest prize. Therefore,
to avoid risk, the dominant strategy is to defect. (S Kuhn, 1997)
In the case with Oligopoly’s appearance, it will be the choice of setting prices, high or low price.
If 2 oligopolies choose to set high price, they will maximize the industry’s profits since they are
price-makers. However, if a firm cheats and set lower price, that firm will penetrate market, since
the products are homogenous, consumers would choose cheaper ones. However, it will result in
punishment, the other player will adjust their price lower than the cheater to penetrate the market
back, and the cycle begins, until both of them cannot lower anymore (>= MC of their products),
and it will be a loss compared to the scenario where both of them cooperate.
To conclude, it is best for both if 2 firms cooperate.

2. Effect of International Trade to the Stakeholders:
In Trade, stakeholders in Home will be affected the same way as Foreign, since each firm in each
country joins trade with existence of oligopoly rival.


Figure 1. Welfare Effect of Trade.
Before Trade (Autarky):
-

Consumer Surplus: Blue area

-

Firm Profit: Black, Orange, Green, and Yellow area.

After joining Trade:
With Transportation Cost (TC):

- Consumer Surplus: Blue, Black, Grey area. Due to the price in Trade being lower than
price in Autarky, consumers gain additional surplus in Black and Grey area. In Trade, firms face
their Oligopoly rival, instead of having absolute pricing power in Autarky, their pricing power in
Trade is divided.


- Firm Profit: Orange, Yellow, Light Blue. Firm loses Black area since the price in Trade is
lower than Price in Autarky. Moreover, area Green no longer belongs to firm profit since it is
being transformed into transportation cost. It is yet to conclude whether firm gain from trade
(with TC), however, since firms lose 2 areas in profit compared to Autarky, while gain back 1
from Trade, the outcome is likely that Oligopoly firms lose if they join Trade.
Without Transportation Cost:
- Consumer Surplus: Blue, Black, Grey.
- Firm profit: Orange, Yellow, Green, Light Blue area. Firm loses black area due to lower price,
while keeping profit from area Grey (were supposed to be TC). In this case, firms lose 1 and gain
1 area, so if Black area is smaller than Light Blue, firms gain from Trade without TC. The
outcome goes opposite if Black is bigger.
Conclusion:
- If Transportation Cost is low enough, and additional Consumer Surplus does not outweigh the
gain from Trade, then Oligopolies still be able to gain from Trade, yet still unlikely.
- Consumers always gain from Trade.
- For the society:
Positivity: increased market competitiveness (Monopoly to Oligopoly), decreased Deadweight
Loss.
Negativity: waste of resources on unnecessary transportation of identical products from other
countries, since the same product existed in domestic. Optimal transportation should be getting


products that is unavailable.
3.

To sell in the foreign market, transportation costs must be considered. If firm 1 wants to
penetrate the foreign market, they need to lower price, meaning they have to choose defect
option (prisoner’s dilemma). However, firms cannot lower prices to equal Marginal Cost +
Transportation Cost. Meanwhile, the rival in that foreign country, firm 2, might have the same
MC for product, but they do not have to care about TC, since they are in homeland. Therefore,
by defecting, the oligopoly rival can lower their price near to MC, which is lower than the lowest
price of what firm 1 can set, as a punishment to firm 1’s action. Moreover, market share when
firm 1 enters foreign market will not be 50% at start since consumers in that country get used to
the image of firm 2. To conclude, penetrating the foreign market in which oligopoly rival existed
is impossible.

Question 2:
Assumption
Due to the fact that (1) the textile industry is manufacturing intensive, it's main factors are labor
(L) and K (capital) and (2) the sugar industry is agricultural intensive, it's main factors are labor
(L) and land (A). As both industries require more unskilled labor which is abundant in Vietnam,
we conclude that while K and A are still specific, factor L is mobile creating a mixed specific
factor model between two industries. Hence, Instead of wages for each industry worker, we have
a single wage for the whole country, at this equilibrium wage the sum of workers in both textile


and sugar industry equals to the total L.

Equilibrium wage

Figure 2: Equilibrium wage before tax adjustment
As Vietnam has a comparative advantage in textile industry and comparative disadvantage in
sugar industry, our country focuses more on producing textile. Therefore, the labor hired by
textile firms should be higher than labor for the sugar industry. The wage of a worker presenting
the extra cost brought by one worker is calculated by multiplying the price of product by the

extra revenue that worker brings to the firm (w = p x MPL). When the two wage curves meet, the
equilibrium price (w) and each industry labor supply is created. Above the wage (w) line and
under curves is textile capitalists’ income (orange sector) and sugar farmers' income (yellow
sector), only part below the wage line (grey sector) is workers' income.


Tax adjustment

Figure 3: Equilibrium wage after tax reduction
As shown in the graph above, if the government lowers the tax rate, only textile capitalists
benefit with an increased income but both sugar farmers and total workers suffer. Tariff reduction
causing the wage curve of the sugar industry shifts down lowers the equilibrium wage, hence
part of the workers' previous income is cut. On behalf of the sugar farmers, though the shift has
brought them a small increase in income from the cut of workers wage, it cannot counterbalance
their loss of quantity supply (stripe yellow sector).

Budget Line
For example, if the tax cut is down to 5%, the price of sugar products will be reduced by 5% but
the wage of workers is reduced less than 5% as increasing in price (p S) leads to decrease in labor
( LS ) resulting in increasing MPLS.
For sugar industry labor, the less than 5% decrease in wage raising their purchasing power in


sugar products but decreasing in textile one. Their budget line is now changed (shown in graph
below).

Figure 4: Sugar workers’ budget line change
On the other hand, for the capitalist, the 5% decrease in price induces their capital rent more
than 5% which weakens their purchasing power in both sugar and textile products. Their budget
line is now changed (shown in graph below).

Figure 5: Sugar capitalists' budget line change
In conclusion, due to the fact that Vietnam has comparative advantage in producing textile not
sugar products, we export garments and tend to import sugar products, therefore with a tariff
deduction, capitalist acted as a specific factor from the import-competing sector are
unambiguously hurt. Therefore, I agree with the Association of Sugar Products of Vietnam
appeal of tariff lowering. Indeed, as the effect of ATIGA on reducing raw sugar tariff, the
imported sugar quantity increases dramatically leading to local price closer to global levels
despite higher production cost, this has hurt both the sugarcane farmers and the local companies
(Van, 2020).


Question 3:
Trading partner analysis
Since Vietnam joined the WTO in 2007, trade activities between the US and Vietnam have made
great progress and increased strongly. In 2019, the United States is Vietnam's third largest trading
partner with annual trade growth of 20%. The total trade value of goods and services was
estimated at $81.3 billion in 2019 ( Ustr.gov 2019), with exports accounting for the largest
partner share 22.9% (appendix 1) (Vietnamcustoms.gov 2019) with $13.4 billion, imports were
$67.9. The US goods and service trade deficit with Vietnam was $54.5 billion for the same year.
According to Demombynes & Testaverde (2018), workers with university degrees or higher only
accounted for 9% in 2013(appendix 2). However, the number was still quite modest compared to
the number of low degrees workers with 91%.

Figure 6: Education Distribution of the Workforce in Vietnam (World Bank 2014)


Figure 7: Jobs by designated education level of occupations in US, May 2013 (BLS.gov, 2014)

According to the U.S. Bureau of Labor Statistics (2014), in 2013, the United States had quite a
high proportion of workers with bachelor's degrees to doctorate degrees with 23% of the total
employees, double than Vietnam. The majority of the 77% remaining workforce belong to the
high school diploma group (39%) or less (27%). Therefore, we have the labor ratio between US
and Vietnam:

( )

( )

9
23 S
S
US❑
VN
❑ = >
❑ =
77 U
91
U

❑

S : percentage of skilled labor

U : percentage of unskilled labor
Because the labor ratio of the US is higher than Vietnam, thus, America is a skill labor abundant
country compared to Vietnam.

HOM implication
Vietnam was ranked as the 13th biggest trading partner of the United States in 2019 with many
imported goods across a range of industries. According to the US Trade Representative (2019),
the top 5 import goods from Vietnam to the US were electronic components ($22 billion), knit
apparel ($7.7 billion), furniture and bedding ($7.2 billion), footwear ($7.0 billion), and woven
apparel ($5.8 billion). Most industries are light and required unskilled labor instead of large
capital. In contrast, main export products from the US require high skill labor and large capital.
In 2019, top 5 categories exporting were electrical machinery ($1.7 billion), cotton ($1.5 billion),
aircraft ($787 million), plastics ($772 million), and machinery ($476 million). To test further
implication of the Heckscher-Ohlin model, we choose 2 main goods which are apparel from
Vietnam and electrical machinery from the US, 2 factors of production, capital and labour to
analyze. Textile and apparel industries are labor intensive because it contain a sewing stage
requiring a lot of low skilled labor but dexterity which is suitable for Vietnamese workers, and no
requirement for high investment in technology or capital (Tot 2014). As mentioned above,
Vietnam is an unskilled labor abundant country compared to the US, with 69.8% of the labor
force residing in the rural areas (Le & Wang 2017 ), and majority of the factories are also located
in rural areas for land availability. Therefore, it was reasonable for Vietnam to choose apparel
(labor intensive) as a key export industry. On the other hand, US exports were the most skilled
and capital-intensive (O’Connor & Lunati 1999) while choosing electrical machinery which is a
highly sophisticated technology industry. Machinery manufacturing jobs primarily required high
skilled labor, professions with well-compensated trades and automation technologies ( Selectusa
2018), thus, machinery manufacture is skilled labor and capital intensive. Moreover, 23% of the
total 159 million US labor force (appendix 3) is skilled and since the beginning of 20 century the
rapid development of technology and automatic machinery has resulted in a significant increase
of labor productivity and capital, which is suitable for a complex technology industry (Baily &
Bosworth 2014). Therefore, both the US and Vietnam tended to export products intensively
related to the country's abundant factors and import the others, which support the implication of
the HOM.

SST implication
As the implication of SST, we expect the skilled labor of the US will benefit from trade and the
unskilled labor suffers hence widening the income distribution. Based on figure 8, the US had a
higher Gini index than Vietnam which demonstrated the higher inequality of individual’s income.
According to the Census Bureau report (2000), they acknowledge the income inequality started
earnestly rising since the 1980s that coincided with the manufacturing shifting from goods
producing industry (create job opportunity for unskilled workers) to technology service
industries (benefit college graduates labor).

Figure 8: Gini index (estimate) between United States and Vietnam (World Bank 2018)


Figure 9: Median Wage by Educational Attainment of US from 1980 to 2018 (Donovan &
Bradley 2019)
Since the export-intensive industry must increase their competitive advantage by investing in
technology and capital, which increase productivity leading to rising demand for skilled labor
and gradually replace low skill workers (Riker 2015). Moreover, the upgradation in product
quality, technology development has created a high demand for US machinery export in the
world, thereby increasing product prices (skilled labour intensive) (World Bank 2019).
Therefore, raising prices for export machinery has benefited the wages of skilled labors
(production factor) and hurt the scarce factors which are unskilled laborers. From 2000 to 2018
(figure 9), there was a slow growth wage of workers less than bachelor's degrees, however, the
widened income gaps resulted from strongest wage growth of labor with advanced degrees
(Economic Policy Institute 2019). Therefore, the rising wages of abundant factors in the US
thanks to trade supports the implication of the SST model.
On the other hand, in Vietnam, unskilled workers in apparel and textile industries benefited from
trade liberalization. With countries having lower domestic prices than the world, selling textile
products at world prices drives up the prices of the industry. Over the last 20 years, overall wages
of skilled labour grew due to the development of the world, however, the fastest growth belongs

to unskilled labor. Specifically, between 1997 and 2004, the salaries of skilled workers only
increased by 11% while unskilled labor rose by 15% (Cling et al. 2009). Therefore, the apparel
industry (unskilled labor intensive) rose prices due to trade lead to the increase in abundant
factors wages and hurt the scare factors which is true with the SST model.

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Appendix:


Appendix 1: Export, Import total value and growth rate of Vietnam in 2019 (Vietnamcustoms.gov
2019)

Appendix 2: Education distribution of work force in Vietnam by years (World Bank 2014)


Appendix 3: Total labor force of the United State from 2000 to 2019 (World Bank, 2019)