Question

2. Consider the model of intra-industry trade with monopolistic competition that woe discussed in the class. (a) Mention and briefly describe the assumptions of the model. (6) (b) Draw a figure depicting the long-run equilibrium with trade. (4)

Answer 1

a)Monopolistic competition is a market structure having the features of perfect competition and monopoly.The model of intra industry trade shows trade between countries that occurs within an industry and not across industries. Eg this model explains why some countries export and import automobiles at the same time. The term is applied to international trade where same types of goods are imported and exported. The assumptions of this model are there are two countries A and B, there are two industries X andY ,there are two factors of production labor and capital which are homogeneous ie they are same,labour is mobile between industries ie it can move,capital is specific to industryie which capital is perfect for the industry,industry X produces identical product,Y produces differentiated product ie product which is different.

b)In the fig quantity is measured along the x axis and price along the Y axis.AC is the average cost curve .In the absence of trade D1 is the demand curve.Long run equilibrium is at R where OQ is the quantity and OP is the price.With trade increased, number of varieties will make the demand curve shift down and the new demand curve D2 is more elastic.The long run equilibrium is at R1output is OQ1 and price is OP1and price will be equal to AC.