6.5. Monopolistic Competition with Trade

Question 1

Five trade assumptions

Answer 1

Home and foreign are exactly the same:
- Same number of consumers.
- Same preferences.
- Same technology and cost curves.
- Same factor endowments.
- Same number of firms as in the no-trade equilibrium.

Question 2

Short-run monopolistic competition with trade

Answer 2

Home and Foreign begin in the long-run equilibrium without trade, at PA with NA firms.

With trade, the two markets integrate, forming 2D demand.
And 2NA firms.

More firms on the market means more products, greater price sensitivity and demand becomes more elastic.

The demand curve shifts from d1->d2.

Each firm has an incentive to produce MR2=MC, at Q2 and P2. Here, they would make monopoly profit.

Since all firms do this, point B is never attained. Instead, we shift leftwards to a point where AC>P, along the demand curve, D/NA, that represents demand should there be no trade.

Question 3

Long-run monopolistic competition with trade

Answer 3

Some firms are making losses and will leave the market.

When firms exit, it increases the demand for the remaining firms’ products and decreases the available product varieties to consumers.

The integrated market will have 2NT firms, which is greater than 2NA.

D/NT exceeds D/NA, share of demand in trade exceeds autarky.

As more firms exit the industry, the number of firms drops to NT.

WIth NT firms, individual demand faced by each firm is d3.

Each firm produces an otimal quantity where MR3=MC and P=AC.

Long-run profits are zero.