6 Increasing Returns to Scale and Monopolistic Competition
1.
a. Of two products, rice and paintings, which product do you expect to have a higher
index of intra-industry trade? Why?
b. Access the U.S. TradeStates Express website at http://tse.export.gov/tse/tsehome.aspx.
Click on “National Trade Data” and then “Global Patterns of U.S. Merchandise
Trade.” Under the “Product” section, change the item to rise (HS 1006) and obtain the
export and import values. Do the same for paintings (HS 9701); then calculate the
intra-industry trade index for rice and paintings in 2012. Do your calculations confirm
your expectation from part (a)? If your answers did not confirm your expectation,
explain.
Answer:
Index of intra–industry trade
=
Minimum of imports and
ex
port
s
2. Explain how increasing returns to scale in production can be a basis for trade.
3. Why is trade within a country greater than trade between countries?
4. 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?
Does the demand curve D/NA still apply after the opening of trade? Explain why
or why not.
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
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
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
5. 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.
b. From the new short-run equilibrium, is there exit or entry of firms, and why?
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
6. Our derivation of the gravity equation from the monopolistic competition model used
the following logic:
(i) Each country produces many products.
(ii) Each country demands all of the products that every other country produces.
(iii)Thus, large countries demand more imports from other countries.
The gravity equation relationship does not hold in the Heckscher–Ohlin model.
Explain how the logic of the gravity equation breaks down in the Heckscher–Ohlin
model; that is, which of the statements just listed is no longer true in the Heckscher–
Ohlin model?
Answer: The Heckscher–Ohlin model assumes perfect competition. Therefore, each
Work It Out
The United States, Japan, and China are among the world’s largest producers. To answer
the following questions, assume that their markets are monopolistically competitive, and
use the gravity equation with B = 93 and n = 1.25.
GDP in 2012
($ billions)
Distance from the
United States (miles)
China
11,385
7,245
Japan
4,116
6,314
United States
17,968
—
a. Using the gravity equation, compare the expected level of trade between the
United States and Japan and between the United States and China.
Answer: The expected level of trade between the United States and China is
b. The distance between Beijing and Tokyo is 1,302 miles. Would you expect more
trade between China and Japan or between China and the United States? Explain
what variable (i.e., country size or distance) drives your result.
Answer: The expected level of trade between China and Japan is 93(11,385 ·
7. What evidence is there that Canada is better off under the free–trade agreement with
the United States?
Answer: Economist Daniel Trefler found that between 1988 and 1996 the
8. In the section “Gains and Adjustment Costs for the United States under NAFTA,” we
calculated the lost wages of workers displaced due to NAFTA. Prior experience in the
manufacturing sector shows that about two–thirds of these workers obtain new jobs
within three years. One way to think about that reemployment process is that one-
third of workers find jobs in the first year, and another one-third of remaining
unemployed workers find a job each subsequent year. Using this approach, in the
table that follows, we show that one-third of workers get a job in the first year
(column 2), leaving two-thirds of workers unemployed (column 4). In the second
year, another (1
3) · (2
3) = 2
9 of workers get a job (column 2), so that (1
3) + (2
9) = 5
9 of the
workers are employed (column 3). That leaves 1 – 5
9 = 4
9 of the workers unemployed
(column 4) at the end of the second year.
Year
Fraction
Finding Job
Total Fraction
Unemployed
1
1
3
1 –
1
3
=
2
3
2
1
3
·
2
3
=
2
9
+
=
1 –
5
9
=
4
9
3
1
3
·
4
9
=
4
27
4
5
6
1
3
· (
2
3
)Year−1
a. Fill in two more rows of the table using the same approach as for the first two
rows.
Answer:
Year
Fraction Finding
Job
Total Fraction
Employed
Total Fraction
Unemployed
1
1
3
1
3
1 –
1
3
=
2
3
2
1
3
3
9
3
9
9
9
3
2
2
1
2
5
5
4
3
27
81
27
81
81
81
81
5
6
1
3
2
3
b. Notice that the fraction of workers finding a job each year (column 2) has the
formula
Using this formula, fill in six more values for the fraction of workers finding a job
(column 2), up to year 10.
Answer:
Year
Fraction Finding
Job
Total Fraction
Employed
Total Fraction
Unemployed
1
1
3
1
3
1 –
1
3
=
2
3
2
1
3
·
2
3
=
2
9
1
3
+
2
9
=
5
9
1 –
5
9
=
4
9
3
1
3
·
4
9
= 0.15
5
9
+ 0.15 = 0.7
1 – 0.7 = 0.30
4
1
3
·
8
27
= 0.10
0.80
0.20
5
0.07
0.87
0.13
6
0.04
0.91
0.09
7
0.03
0.94
0.06
8
0.02
0.96
0.04
9
0.01
0.97
0.03
10
0.01
0.98
0.02
c. To calculate the average spell of unemployment, we take the fraction of workers
finding jobs (column 2), multiply it by the years of unemployment (column 1),
and add up the result over all the rows. By adding up over 10 rows, calculate what
the average spell of unemployment is. What do you expect to get when adding up
over 20 rows?
Answer: We get 2.79 over 10 years, and would expect ≈3 over 20 years.
Year
Fraction
Finding Job
Total
Fraction
Employed
Total
Fraction
Unemployed
Average
Spell
1
0.33
0.33
0.67
0.33
2
0.22
0.56
0.44
0.44
3
0.15
0.70
0.30
0.45
4
0.10
0.80
0.20
0.40
5
0.07
0.87
0.13
0.35
6
0.04
0.91
0.09
0.24
7
0.03
0.94
0.06
0.21
8
0.02
0.96
0.04
0.16
9
0.01
0.97
0.03
0.09
10
0.01
0.98
0.02
0.10
Sum = 2.79
d. Compare your answer to (c) with the average three-year spell of unemployment
on page 191. Was that number accurate?