Answer the questions below based on this diagram, which represents the situation for a
monopolistically competitive firm in the short run after a country has "opened up" to trade. You may assume that point A is the long-run equilibrium without trade ("autarky") and NA is the number of firms in the autarky (no trade) equilibrium and when the country "opens up" to trade.
a. Explain the meaning of the two demand curves: what is the difference between d2 and D/NA? Why is d2 flatter?
b. How does the firm try to maximize its profits in the above situation, that is what pulls it away from the autarky equilibrium at point A? Where does the firm try to operate, at B or B¢, and why? Where does the firm end up producing, at B or B'?
c. What adjustments are set in motion by the situation you have just described in part b? Specifically, will firms enter or exit the industry, and why?
d. What will happen to output, average cost, price, and profits for each domestic firm in the long-run equilibrium with trade? A graph is optional, but fully explain what happens in moving to the long-run equilibrium with trade.
e. Summarize (qualitatively) the types of "gains from trade" that are found in this model.
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