# tradeexample5 - n(d Plot AC as a function of n and P as a...

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Example 5 Suppose that in the economy there is a single industry and that in this industry there are increasing returns to scale. The cost function of the typical firm is: . Q c F C × + = (1) Demand facing a firm in this industry is given by: () [ ] . / 1 P P b n S Q × × = (2) (a) Give a verbal interpretation of these equations. Give a brief description of the types of cost that F might represent. How many goods does each firm produce? What determines consumer welfare in this model? (b) Derive average cost AC . Given that all firms are symmetric, in equilibrium it is reasonable to expect that . P P = Use this in (2) to get an expression for Q and then use the result to express AC as a function of the number of firms in the market. How and why is AC related to n ? (c) Use the fact that MR = P Q/ ( Sb ), and equation (2) when P P = , to show the relationship between the price that the firm charges when it maximizes profits and the number of firms
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Unformatted text preview: n . (d) Plot AC as a function of n and P as a function of n on the same diagram. Pay careful attention to the slopes of the functions and the intercepts. Determine the equilibrium price and equilibrium number of firms on the diagram. (e) What is the relationship between P and AC in equilibrium? What does this mean for profits in the industry? What is the key assumption driving this outcome? (f) How can we represent the opening of international trade in this economy? Illustrate using the diagram from (d). What happens to price and the number of firms? What is the impact of international trade on welfare? (g) Solve algebraically for the number of firms in equilibrium. Illustrate the relationship between the ‘size of the market’ and the number of firms on a diagram. Use this diagram to explain the assertion that ‘globalization increases concentration.’...
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