1. The world economy consists of one, giant country, occupying an entire continent, Pangaea. Pangaea is a developed, modern economy, where consumers enjoy many varieties of every good. Each sector of this economy is well captured by the monopolistic competition model studied in class. As a result of a civil conflict, the country splits into two new countries, North Pangaea and South Pangaea, of roughly equal size (in terms of people, land, and resources). The two new countries do not trade with each other.
(a) Use the main diagram of the monopolistic competition model under symmetry (hint: PP and CC) to show what happens to the number of varieties and the price charged, by comparing before and after the break-up. (Label axes, curves and key coordinates!)
(b) Briefly explain how consumers are impacted by this change. (Hint: what do consumers care about/like?)