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Problem%20Set%20_4b%20ANSWERS - Econ 181 International...

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Econ 181: International Trade Spring 2009 Problem Set #4b (Due Tuesday, April 7, 2009) 1. Article Analysis—Intra-industry Trade: Read this article and answer the following questions. Sabra Chartrand, “Stepping Up the Pressure Against Piracy in China”. The New York Times, December 6, 2004. The URL is: a. Why is piracy an issue that is relevant for intra-industry trade? Firms that engage in intraindustry trade have large fixed costs, and therefore declining average costs. Firms that have large fixed costs spend billions of dollars creating intellectual property, and it is precisely firms in these industries that are the target of piracy, "DVD's, CD's and digital games" and "clothing and prescription drugs." All these industries have high fixed costs and relatively low marginal costs. b. How is piracy affecting international trade? For one, it is raising administrative and border costs to nations attempting to stop the flow of counterfeit or pirated goods. The more subtle and nefarious effects of piracy are the undermining of intellectual property rights and reducing incentives for innovation. By counterfeiting goods and smuggling them into industrialized countries, Chinese pirates are making it more difficult for firms to recoup their substantial fixed cost investments. This will ultimately reduce the production and trade of these differentiated products. c. Could the amount of piracy in China be related to the lack of price discrimination? It's certainly possible. Because per capita income in China is so much lower than the industrialized world, the willingness to pay for luxuries such as CDs and DVDs would also be much lower in China. So the emergence of piracy in China may be due at least in part to the failure of rich country firms to sell the goods less expensively in the developing world. The reason that these intraindustry trading firms are not engaging in this price discrimination, of course, is because it would create arbitrage opportunities by selling the goods back to rich countries. The possibility of arbitrage rules out significant price discrimination, so there is something of a market failure here. d. The president of the International Intellectual Property Alliance states that "[a] CD costs 15 cents to produce." If that is true then why do CDs cost upwards of 100 times that in retail markets? This is another feature of monopolies or monopolistically competitive industries—firms charge a price greater than marginal cost because products are differentiated, and the higher price goes to paying the higher fixed costs related to product development.
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2. Model Analysis—Imperfect Competition. Suppose the widget industry operates in the home country such that
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Problem%20Set%20_4b%20ANSWERS - Econ 181 International...

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