International Economics 2nd Edition By Feenstra – Test Bank & Solution Manual

International Economics 2nd Edition By Feenstra – Test Bank & Solution Manual

and Monopolistic Competition
1. Explain how increasing returns to scale in production can be a basis for trade.
Answer: With increasing returns to scale, countries benefit from trade due to the potential to reduce their average costs by expanding their outputs through selling in a larger market.
2. Why is trade within a country greater than trade between countries?
Answer: Border effects prevent trade between countries from being as large as within countries. These factors include tariffs, quotas, administrative rules and regulations, and whether the countries have a common border or language.
3. Starting from the long-run equilibrium without trade in the monopolistic competition model, as illustrated in Figure 6-5, consider what happens when the Home country begins trading with two other identical countries. Because the countries are all the same, the number of consumers in the world is three times larger than in a single country, and the number of firms in the world is three times larger than in a single country.
a. Compared with the no-trade equilibrium, how much does industry demand D increase? How much does the number of firms (or product varieties) increase? Therefore, does the demand curve D/NA still apply after the opening of trade? Explain why or why not.
Answer: Industry demand increases by three times, and the number of firms also increases by three times. Compared with the no-trade equilibrium, the demand curve D/NA does not change because both total quantity demanded and the number of firms tripled.
b. Does the d1 curve shift or pivot due to the opening of trade? Explain why or why not.
Answer: Because D/NA is unchanged, point A is still on the short-run demand curve facing each firm (d2 in Figure 6-6). However, the demand curve faced by
S-49
each firm becomes more elastic due to the increase in the number of firms: d1 pivots to become flatter.
c. Compare your answer to (b) with the case in which Home trades with only one other identical country. Specifically, compare the elasticity of the demand curve d1 in the two cases.
Answer: In the case with three countries, Home consumers have more varieties to choose from compared with the two-country case. For that reason, the demand curve facing each firm is flatter (more elastic) when there are more trading partners.
d. Illustrate the long-run equilibrium with trade and compare it with the long-run equilibrium when Home trades with only one other identical country.
Answer: The long-run equilibrium with trade occurs where the demand curve facing the firm is tangent to the average cost curve, to the right of the long-run equilibrium without trade (due to the exit of firms from the industry). Because the demand curve facing each firm with trade (d3) is flatter when there are three countries compared with two, it will end up further down the average cost curve in Figure 6-7. Therefore, firms will produce a greater quantity, at lower average cost, than the in the two-country case.
4. Starting from the long-run trade equilibrium in the monopolistic competition model, as illustrated in Figure 6-7, consider what happens when industry demand, D, increases. For instance, suppose that this is the market for cars and lower gasoline prices generate higher demand D.
a. Redraw Figure 6-7 for the Home market and show the shift in the D/NT curve and the new short-run equilibrium.
Answer: The increase in demand shifts the D/NA curve to the right, dragging along the curves d3 and mr3. Each firm produces Q4 at a price of P4 attempting to earn monopoly profits at point D, and when all firms do so they move along

Solutions ■ Chapter 6 Increasing Returns to Scale and Monopolistic Competition S-51
b. From the new short-run equilibrium, is there exit or entry of firms, and why?
Answer: In the short-run with trade, monopoly profits are positive because price exceeds average cost. As a result, firms enter the industry and NT increases.
c. Describe where the new long-run equilibrium occurs, and explain what has happened to the number of firms and the prices they charge.
Answer: In the long-run with trade, firm entry shifts D/NT and d4 to the left and makes d4 more elastic until it is tangent to the average cost curve. At that point, monopoly profits are zero and firms no longer enter the industry. Relative to the short-run equilibrium in (b), the number of firms increases and price decreases.