Econ322,Spring2016.docx

Econ 322, Spring 2016 Answers to Problem Set 3 Chapter 6,Problem 1: In the presence of increasing returns to scale, countries benefit from trade by moving down their average cost curve (reduce their average costs) via expansion of output. This happens because they get access to a larger market. Consumers gain from the lower prices and greater product variety. Chapter 6,Problem 3: Starting from the long-run equilibrium without trade in the monopolistic competition model, as illustrated in Figure 6-5, consider what happens when the home country begins trading with two identical countries. Because the countries are identical, the number of consumers in the world is three times larger than in a single country, and the number of firms in the world is three times larger than in a single country. P Q Short-run Equilibrium without trade d1 d0 Long-run equilibrium without trade MC mr1 PA Po D/NA Q1 Q0 AC Figure 1: Short-run and Long-run Monopolistic Competition Equilibrium without Trade Figure 1 P Q Long-run equilibrium without trade MC PA Po D/NA d2 Q1 Q0 mr2 P2 Q2 Q’2 AC Short-run equilibrium with trade (3 countries) Figure2 : Short-run and Long-run Monopolistic Competition Equilibrium after Trade Figure 2 Compared with the no-trade equilibrium, how much does industry demand D increase? How much does the number of firms (or product varieties) increase? Therefore, does the demand curve D/NA still apply after the opening of trade? Explain why or why not? Industry demand is 3 times larger compared to that without trade. The number of firms also triples. The demand curve D/NA still applies (3D/3NA = D/NA ). Does the d1 curve shift or pivot due to the opening of trade? Explain why or why not? d1 curve becomes flatter (see d2 in Figure 2) due to an increase in the number of varieties available to consumers after trade (which makes them more price sensitive). Compare your answer to (b) with the case in which Home trades with only one other identical co