Economies Of Scale (autarky To FT (convex PPF As IRS), And liking for variety

Question 1

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

Answer 1

Specialisation - no point in producers producing a variety

Since greater production of both goods, so gains from trade are possible!

Question 2

Imp: Autarky equilibrium with IRS pg 6

Answer 2

Convex PPF, and indifference curve, countries both produce and consume at A

(this is optimal for countries to produce both goods.. since wastes their IRS and EOS!)

Question 3

Imp: Now go from autarky to free trade diagram,

with EQUAL GAINS (we explore differential gains next) pg7

B) what happens to prices

Answer 3

With free trade, countries specialise (as mentioned)

We use free trade prices Pw, new consumption point Z.

(Next diagram)

Question 4

Imp: Free trade equilibrium with differential gains pg 16

assume country A specialises in the good that sees a price increase

Answer 4

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)

(Pw still parallel)

Question 5

2 theories of monopolistic competition

Answer 5

Liking variety
Differentiated consumers

Question 6

Liking variety model assumption

Answer 6

Consumers utility considers variety, not just quantity

Question 7

Price equation

(hint: includes elasticity of demand)

Answer 7

P = [1/ 1-(1/ε)]c

ε is elasticity of demand
c is MC

Question 8

Relationship between ε and n

Answer 8

Positive relationship between ε and n

So if n increases, each firm’s market share falls, so ε increases (more responsive to prices), so prices will fall (unable to charge a high mark-up above MC)

Thus negative relationship between n and P (constrasts result we found n increases P P=nF/s + c)

Question 9

Pg 15 diagram to show relationship between P and n

B) what does this line also show us

Answer 9

Instead we see a downward sloping line to show as N increases, price falls!

B) purple line shows us market power

Question 10

Liking for variety autarky equilibrium

Answer 10

Normal profits (since P=C (C is AC)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

Purple downward sloping line is market power
Blue line is average cost

Question 11

Liking for variety - free trade equilibrium pg17

Answer 11

Under free trade, more competition!

So increase in firm number, and we see a fall in c (AC) - shifts to the right

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

Question 12

So free trade increases in market size raises n (shifts C>C1) and lowers P

Gains from trade aises from 2 sources

Answer 12

Consumers gain from a fall in prices

Consumers gain from varieties

Question 13

What does diagram look like with constant elasticity of demand pg19

Answer 13

If constant ε, market power is constant thuhs

Purple line showing market power is horizontal (market power does not change even when number of firms increase (n))

Question 14

Differentiated consumers model assumptions (2)

Answer 14

Consumer buys at most one unit (either 1 or none), but prefer different varieties of the product.

Each firm producers a single variety, with IRS

Question 15

Salop’s circular model

Answer 15

4 firms, each firm produces a good for a segment in the market. If a consumer falls in that segment, they sell to that consumer.

Question 16

Differeniated consumer: autarky vs free trade (pg 23)

Answer 16

Trade can be thought of as doubling the size of market

Consumer originally preferred variety was 2. Now at free trade they lie inbetween 2 and 3, i.e can no longer buy their preferred variety so is worse off.

Distance between a firm and consumer reprrsents how close the variety produced is to the consuers PREFERRED variety