Hello, dear friend, you can consult us at any time if you have any questions, add WeChat: daixieit

ECON - Problem Set C

Monopolistic Competition, Horizontal Intra-Industry Trade, and Firm Dynamics

The world consists of two countries, Dampier and Wanaka.

•   In  each  country, there  are n firms  active  in the  electric vehicle  (EV)  industry.  Each firm produces a differentiated EV model with the fixed cost F and the marginal cost c.

•   The market demand for each EV model is Q = − s(P − ), where P denotes the price of a particular EV model and the market size S is independent of the average price .

•   Each firm is a monopolistic competitor, with the marginal revenue function MR = P − Q

•   As firms face the same fixed cost and the same marginal cost, they optimally set the same price P = and the market demand for each EV model becomes Q = − s(P − ) = .

•   Due to free entry, the long-run profit is zero for individual firms.

Impacts of Trade on the Prices and Variety of Differentiated Products

(a) Under autarky, firms in the two countries use the same technology (F = 100 and c = 5) to serve their respective domestic market. The market size of Dampier is sD  = 6400, and that of Wanaka is sw  = 22500. Calculate the autarkic values of n, Q, and in each country. In which country is the EV price lower? Explain the economic mechanism.

(b) Today, Dampier and Wanaka sign a free trade agreement (FTA) so that individual firms face a fully integrated world market with the size of sT  = sD  + sw  = 28900 . Use the CC and the PP curves to explain graphically the short-run and long-run impacts of FTA on firm profits, product variety, and average price. Calculate the EV variety n and the average price under free trade. How does the FTA affect consumer welfare and the world total spending on fixed costs in the short run and in the long run?

Selection Effect of Trade in the case of Heterogenous Firms

(c) Suppose firms have the same fixed cost F, while they differ in the marginal cost c ∈ (0, ∞). Under autarky, show graphically and explain intuitively how the sales, the price, and the operating profit of individual firms depend on their marginal cost c. What kinds of firms are active in the autarkic equilibrium?

(d) Use diagrams to show how the FTA affects the market demand curve for individual firms. Explain intuitively how the FTA affects the sales and the price of firms with different marginal costs. Use diagrams to show which firms expand, which firms shrink, and which firms have to  quit from the  market.  Explain the  economic  mechanism.  How  does trade  affect the average productivity in each country as well as in the world economy?