Scribd
Upload
220 views4 pages

Trade Benefits from Increasing Returns

This document contains solutions to problems from an international trade course. In problem 2, it explains how increasing returns to scale can benefit trade by allowing countries to reduce costs by expanding output across larger markets. Problem 3 analyzes the effects of opening trade between identical countries in a monopolistic competition model. It finds that industry demand and the number of firms triples, causing the demand curve facing individual firms to pivot outward and become more elastic. With more trading partners, firms produce more at lower costs in the long-run equilibrium. Problem 9 notes that trade within a country is greater than between countries due to "border effects" like tariffs and administrative rules.

Uploaded by

Remas Alhawari
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
220 views4 pages

Trade Benefits from Increasing Returns

This document contains solutions to problems from an international trade course. In problem 2, it explains how increasing returns to scale can benefit trade by allowing countries to reduce costs by expanding output across larger markets. Problem 3 analyzes the effects of opening trade between identical countries in a monopolistic competition model. It finds that industry demand and the number of firms triples, causing the demand curve facing individual firms to pivot outward and become more elastic. With more trading partners, firms produce more at lower costs in the long-run equilibrium. Problem 9 notes that trade within a country is greater than between countries due to "border effects" like tariffs and administrative rules.

Uploaded by

Remas Alhawari
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

PROBLEM SET 5 SOLUTIONS

International Trade
Georgetown University School of Foreign Service in Qatar
Spring 2023

2. Explain how increasing returns to scale in production can be a basis for trade.
Answer: With increasing returns to scale, countries benefit from trade because of the
potential to reduce their average costs by expanding their outputs through selling in a
larger market. If you think about trade among centers of economic activity within a
country compared to trade among countries in terms of a gravity equation, the fact is that
centers of economic activity within a country are typically much closer together than
most pairs of countries are. In addition, centers of economic activity within a country
typically have common languages, common regulatory regimes, and they are generally
not separated by borders that require international documentation to cross. These effects
are powerfully illustrated by the data and discussion associated with Figure 6-9.

1
3. Starting from the long-run equilibrium without trade in the monopolistic competition
model, as illustrated in Figure 6-5 below, 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.

Figure 6.5

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? 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 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 ( in Figure 6-6). However, the demand curve faced by each firm
becomes more elastic due to the increase in the number of firms: pivots to become
flatter, like in Figure 6-6 below.

2
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 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 ( ) is flatter when there are three countries compared
with two, it will end up farther 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.

3
9. In the analysis of the gravity equation, explain why trade within a country was found to be
greater than trade between countries.
Answer: This is called the border effect of trade between two regions in different
countries due to tariffs, quotas, other administrative rules or regulations, whether two
countries share a border, and cultural factors.

You might also like