1.   The exam has two (2) questions, with each question worth 20 marks. The exam is worth a total of 40 marks plus 2 bonus marks. You should answer both questions.

2.   You need to paste the following statement at the beginning of your answer file:

I declare that all the work I am submitting is my own, and that I did not receive help from anyone else, including other ECON341 students, to complete my exam, over the 24 hour period during which the exam was available.

3.   The exam is available on Canvas for 24 hours, starting from 13:00 NZT, June 30. You should be able to complete the exam in three hours. You do not need 24 hours to complete it.

4.   The exam is “open book” format. Your answers should focus on analysis, explanation, and interpretation, rather than recall of facts or concepts. The answer to each sub-question is word-limited to 200 words, excluding equations and diagrams. If you exceed this word limit for any sub-question, any words  in excess of 200 words for that sub-question’s answer will not be marked.

5.   You may either type or hand-write your answers to the questions. In case you hand-write your answers, please make sure that your uploaded version is clearly readable. Please start each question’s answer on a new page, and label your answers to each question: “Question 1 Answer”, “Question 2 Answer”, etc. Do NOT include the text of the questions as part of your answers. When you have completed the exam and are ready to submit, you must create a single PDF document (your “answer file”) containing your answers, including diagrams.

6.   You must upload your answers as a single PDF file on to Canvas by 13:00 NZT July 01. However, please do not wait until the last minute for submission. Late submissions will not be accepted. ONCE YOU HAVE SUBMITTED YOUR FILE TO CANVAS, CHECK THAT YOU CAN   SEE   IT   IN   CANVAS.   Clickhttps://community.canvaslms.com/docs/DOC-10663- 421254353for the instructions on uploading a file to Canvas.

7.   Your answer file will  be evaluated automatically via Turnitin for  plagiarism detection. Do NOT directly upload your assignment to Turnitin (via the Turnitin website), as this will result in your assignment not being submitted for grading in the Canvas framework. Note: you cannot delete a file once it is uploaded. The most recent submission will be marked. Please ensure that your most recent upload is the correct version of your assignment.

8. Illness or misfortune affecting your ability to complete the exam.

If you suffer an illness or misfortune that affects your ability to complete the exam and/or submit it on time, you will need to contact your lecturer, Haiping Zhang. You will need to apply through the formal channels for an Aegrotat or Compassionate

Assessment.

9.  If you wish to raise concerns during the Final Assessment, please call the Contact Centre for advice: Auckland: 09 373 7513, Outside Auckland: 0800 61 62 63, International: +64 9 373 7513.  For any Canvas issues, please use 24/7 help on Canvas by chat or phone.

Monopolistic Competition and Horizontal Intra-Industry Trade

The world consists of two countries, Everest and Yosemite. In each country, there are n firms active in the smartphone industry. Each firm produces a differentiated phone model with the fixed cost F and the marginal cost c. The market demand function for a particular  phone  model  is Q = − s(P − ) , where P denotes the  price of the  phone  model and the  market size S is independent of average phone price . Each firm is a monopolistic competitor, with the marginal

revenue function MR = P − Q Firms can freely enter into and exit from the market.

Scenario 1: Gains from Trade Integration in the Case of Homogenous Firms

As firms are homogenous in terms of F and c, they set the same product price in equilibrium.

(a) Under autarky, firms in each country use the same technology (F = 50 and c = 3) to serve the

domestic market. Everest has a market size of sE  = 450, while Yosemite has a market size of sY  = 800 .  Explain intuitively which country  has a  larger  product variety and a  lower average price in the autarkic equilibrium. Calculate numerically product variety, sales per firm, average price, the total fixed cost of all firms in each country. (3 marks)

(b) The two countries are initially in the autarkic equilibrium. Today, they sign a free trade agreement (FTA) and firms can immediately serve the fully integrated world market with the size of sT  = sE  + sY . As firm entry/exit takes time, the number of firms in each country does not respond to FTA in the short run. In the long run, the total number of firms in the world market is determined by the endogenous firm entry/exit.

•  Use the CC and the PP curves to show the short-run and long-run impacts of FTA on product variety, average cost, and average price in the world market. (2 marks)

•  Calculate the short-run and the long-run values of product variety, sales per firm, average price, profit per firm, total fixed cost in the world market after FTA. (2 marks)

•  Explain the economic mechanism through which FTA affects firm profit, consumer welfare and the world production efficiency (in terms of total fixed costs).      (3 marks)

Scenario 2: Losses from Trade Decoupling in the Case of Heterogenous Firms

The two countries are initially under free trade. Firms have the same fixed cost F, while they differ in the marginal cost c e (0, ∞) in each country.

(c) Use the market demand curve and the marginal revenue curve to show graphically and explain intuitively how the sales, the price, and the operating profit of individual firms depend on marginal cost c. Under what condition can a firm actively produce under free trade? (4 marks)

(d) Due to geopolitical and economic conflicts, the two countries decide to terminate their trade relationship and return to autarky from today onwards.

•  Show graphically and explain intuitively how trade decoupling affects the shape of the market  demand  curve for  individual firms,  and the  sales  and the  price  of firms with different marginal costs. (2 marks)

•  How does trade decoupling affect the profit of existing domestic firms in each country in the short run? Which firms expand, which firms shrink, and which firms enter the market in each country in the long run? Explain your findings intuitively. (2 marks)

•  How does trade decoupling affect consumer welfare, the average production cost in each country, and the average production cost in the world economy? (2 marks)