Abstract

This paper applies the Jones–Kierzkowski model to the contract manufacturing service industry. Stylized facts of that industry imply a theory of non-convex general equilibrium. The cost structure combines a constant marginal cost and a positive fixed cost; Marshalian free entry-free exit prevails. This implies a distinct market structure (which is neither perfect nor monopolistic competition, nor the usual Bertrand oligopoly) and a generalized equilibrium concept, based on the ‘full employment’ and ‘competitive profit’ conditions.

In a class of examples where the technology is Ricardian for fabrication and Leontief for assembly, with fixed costs for ‘service links’, it is proved that there always exists Pareto optimal allocations, supported by a concept of generalized equilibrium (but–as shown by Koopmans–not by the Walras equilibrium, where the firms with increasing returns operate as price takers). Implications on specialization and cross country income distribution are noted.

Keywords: Contract manufacturing; Division of labor; Fixed cost; Fragmentation; General equilibrium; International trade; Nonconvexity