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costs for a firm… Show more Consider the monopolistic comp

costs for a firm… Show more Consider the monopolistic competition model we covered in class. Suppose that fixed costs for a firm in the car industry are $5 billion and that variable costs are equal to $17,000 per finished car. Because more firms increase competition in the market, the market price falls as more firms enter the car market, or specically p = 17; 000 + 150=n, where n represents the number of firms in a market. Assume that the initial size of the US and European car markets are 300 and 300 million people, respectively. (a) Calculate the equilibrium number of rms in the US and European car markets without trade. (b) What is the equilibrium price of cars in the US and Europe if the car industry is closed to foreign trade? (c) Now suppose that the US signs a free trade agreement in cars with Europe. The trade agreement with the Europeans adds 300 million consumers to the car market, in addition to the 300 million in the US. How many car rms will there be in the US and Europe combined? What will be the new equilibrium price of cars? (d) Why are prices in the US dierent in (c) and (b)? Explain. (e) Do countries benet by opening to trade? If so, explain why traditional” models (like the Heckscher-Ohlin or the Ricardian model) would predict no gains from trade in this environment, while the monopolistic competition does predict that countries gain by opening to trade. What are the sources of gain from trade in the monopolistic competition model? Clearly explain what drives the welfare gains in this setup • Show less

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