Economies Of Scale

Question 1

So far we assume CRS, but we need to consider EOS

What wouldl happen

Answer 1

Increasing returns to scale - output increases at a faster rate to input

Question 2

EOS external v internal

Question 3

What is optimal in an economy with 2 homogenous goods and IRS

Answer 3

Specialisation - no point in producers producing a variety (both goods)

Thus, complete specialisation creates greater production of both goods, so gains from trade are possible!

Question 4

IRS diagram (in autarky)

Question 5

IRS with free trade, no longer at autarky

B) what happens to prices

Answer 5

With free trade, countries specialise (as mentioned)

We use free trade prices, and … is not possible, so price of … increases so we get new consumption point Z.

(Next diagram)

Question 6

Free trade equilibrium with differential gains (change in prices)

Answer 6

Country A’s indifference curve is higher, as by luck, they specialised in the good with a price increase.

Basically specialising in a good that will have a price rise in future will make them better off (simple)

Question 7

2 theories of monopolistic competition

Answer 7

Liking variety
Differentiated consumers

Question 8

Liking variety model assumption

Answer 8

Consumers utility considers from varieties consumed, not just total quantity consumed

IRS

N firms in industry, each selling 1/n output

Question 9

TC and AC Cost function for liking for variety model

Answer 9

TC = F + cx

AC = F/x + c

X is firm output

Question 10

If total sales in industry are S and remember n firms in the industry each sells a share 1/n of industry output.

What is firm output X

Answer 10

x = S/n

Question 11

Can we find price from this

Answer 11

P = AC = nF/S + c

As in monopolistic competition P = AC

Question 12

Liking for variety

Answer 12

If we increase n, nF/S increases (as part of AC equation on previous page) , and thus should charge a higher price to compensate

But does this actually happen? Is the higher price possible? Have to consider demand

Question 13

What happens to demand

Answer 13

As n increases, firm’s share falls, prices will fall

Question 14

Pg 14

Question 15

14

Question 16

14

Question 17

Liking for variety autarky equilibrium

Answer 17

Normal profits where no incentive for entry or exit

E.g if firm number is > n₀ then cost>price and so make a loss, so incentive to leave, and prices rise back up

Question 18

Liking for variety - free trade equilibrium

Answer 18

As firm number increases, n₀>n₁ , market power (moves along lower down purple line) , cannot charge as much as you could, so price falls.

Question 19

Gains from trade aises from 2 soiurces

Answer 19

Consumers gain from a fall in prices

Cnosumers gain from varieites

Question 20

Gains from trade with constant PED diagram

Answer 20

Purple line showing market power is horizontal (market power does not change with number of firms changing (n))

Question 21

Differentiated consumers model assumptions

Answer 21

Each consumer wants to buy at most one unit (either 1 or none).

However prefer different varieties of the product.

Each firm producers a single variety

IRS

Question 22

What model is used for differentiated consumers model

Answer 22

Salop’s ciruclar model

Question 23

Salop’s circular model

Answer 23

4 firms, distance vetween a firm and consumer reprrsents how close the variety produced is to the consuers PREFERRED variety

Question 24

Differeniated consumer: autarky vs free trade

Answer 24

Trade can be thought of as doubling the size of market