370_Homework-5_AK

370_Homework-5_AK - Econ 370 Spring 2011 International...

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Econ 370 Spring 2011 International Trade Professor Soderbery Homework 5 ANSWER KEY 1. Starting from the long-run equilibrium without trade in the monopolistic competition model, as illustrated below, consider what happens when the Home country begins trading with two other identical countries. Because the countries are all the same, 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. a. 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. Answer: Industry demand increases by three times, and the number of firms also increases by three times. Compared with the no-trade equilibrium, the demand curve D/NA does not change because both total quantity demanded and the number of firms tripled. b. Does the d1 curve shift or pivot due to the opening of trade? Explain why or why not. Answer: Because D/NA is unchanged, point A is still on the short-run demand curve facing each firm (d2 in Figure 6-6). However, the demand curve faced by each firm becomes more elastic due to the increase in the number of firms: d1 pivots to become flatter. c. Compare your answer to (b) with the case in which Home trades with only one other identical country. Specifically, compare the elasticity of the demand curve d1 in the two cases.
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International Trade Professor Soderbery Answer: In the case with three countries, Home consumers have more varieties to choose from compared with the two-country case. For that reason, the demand curve facing each firm is flatter (more elastic) when there are more trading partners. d. Illustrate the long-run equilibrium with trade and compare it with the long-run equilibrium when Home trades with only one other identical country. Answer: The long-run equilibrium with trade occurs where the demand curve facing the firm is tangent to the average cost curve, to the right of the long-run equilibrium without trade (due to the exit of firms from the industry). Because the demand curve facing each firm with trade (d3) is flatter when there are three countries compared with two, it will end up further down the average cost curve in Figure 6-7.Therefore, firms will produce a greater quantity, at lower average cost, than the in the two-country case. d2
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This note was uploaded on 02/06/2012 for the course ECON 370 taught by Professor Staff during the Fall '08 term at Purdue.

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370_Homework-5_AK - Econ 370 Spring 2011 International...

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