differentiated goods, that is, they are not identical. imperfect competition, firms can influence the price they charge Monopolistic competition has two key features: 1. The goods produced by

different firms are differentiated. 2. Firms enjoy increasing returns to scale, by which we mean that the average costs for a firm fall as more output is produced.

Intra-industry trade deals with imports and exports in the same industry. Gravity equation- large countries trade the most Monopolistic competition

o Assumption 1: Firms produce similar but differentiated goods. (also the firm has some control over the price it charges and has a downward demand curve)

o Assumption 2: There are many firms in the industry.o Assumption 3: Firms produce using a technology with increasing

returns to scale. (each unit cost less to make than the last one)o Assumption 4: firms can enter and exit freely so monopoly profits are

zero in the long run. ( firms enter until they cant make monopoly profits, the more that enter the worse the profits for each become) (profits reach zero in the long run)

Monopolistic competition in the short run without tradeo Same as monopoly equilibriumo Firms produce Q where Marginal Revenue MR equals marginal cost

MC and charge price P. If price exceeds average cost than monopoly profits are made.

Monopolistic competition in the long run without tradeo New firms enter shifting demand curve to the left and becomes more

elastic (flatter curve) .o Long run equilibrium is Q when MR=MCo Price equals average costo Zero monopoly profits o No entry or exit

Monopolistic competition in the short run with free tradeo Home and foreign have the same, number of consumers, technology,

cost curves—Normally this would lead to no trade under Ricardian (technology) and Heckscher-Ohlin (factor endowments) models.

o Opening trade increases number of customers and number of firms same ratio, more variety of goods.

o All firms lower price. Some firms will have P less than the AC of the good, incurring losses. Some firms will leave the industry.

Monopolistic competition in the long run with free trade. o Trade opens up so more customers and firms total but the same ratio. o More variety of goods, increasing elasticity for each type. o In the long run firms leave until monopoly profits reach zeroo More elastic demand curve due to more products

o GAINS FROM TRADE: A drop in price from increasing returns to scale. Gains from trade to consumers. (more variety in products)

o ADUSTMENT COSTS FROM TRADE: As firms close workers are displaced and need to find new jobs (short term problem)

The monopolistic competition model has two sources of gains from trade:o The rise in productivity due to expanded output by surviving firms,

which leads to lower prices, ando The expansion in the overall number of varieties of products available

to consumers with trade, despite the exit of some firms in each country.

NAFTA- o USA- long run gains, expansion in varieties, fall in consumer priceso USA and Canada- Long run gains exceeded short run costso Mexico- gains have not helped workers “real wage” except in the

maquiladora sector Intra-industry trade

o What portion of trade in each product is an import or export. 100% means that its equal import and export. 0% means its all import or all export.

o Index of intra-industry trade= (minimum of imports and exports)/(.5(imports + exports))

Gravity equationo Jan Tinbergeno Countries with higher GDPs and are closer to each other will have

more trade. Border effects

o Tariffs- taxes on importso Quotas- limitso Administrative rules and regulations affecting trade- time it takes to

clear customso Geographic factors- share a boarder or noto Cultural factors- common language

Conclusions o Gains from trade when firms have differentiated products and

increasing returns to scale.o Model of monopolistic competition shows that trade will occur

between countries even when they are identicalo Trade within same industries across countries because they can sell to

a larger marketo Firms have to lower prices than when there is no tradeo Remaining firms increase their output and average cost falls. Lower

costs result in lower prices for consumers in the importing countries.

Chapter 7

o Import tariffs and quotas under perfect competitiono Trade policy- government action meant to influence the amount of

international tradeo Gains from trade are unevenly spread across industries so the government

limits losses (or increases gains) from international tradeo GATT- 1947- reduce barriers to international trade between nations

o Same tariffs to all trading partners that are WTO memberso Tariffs may be imposed in response to unfair trade and dumpingo Countries should not limit the quantity of goods and services they

importo Countries should not declare export subsidies provided to particular

firms, sectors, or industrieso Countries can temporarily raise tariffs for certain products.

(safeguard provision) (says that a country can temporarily raise the tariff when domestic producers are suffering due to import competition)

o Regional trade agreements allowed by GATT and Article xxiv Free trade areas- countries agree to remove trade barriers

between themselves Customs unions- free trade areas in which the countries also

adopt identical tariffs between themselves and the rest of the world

o Tariff on welfareo P becomes p+wo Causing consumer surplus to fall by A[new price-old price]+B[new

supply-old supply]+C[new demand- new supply]+D[old demand-new demand]

o A=producer surplus, C=government revenueo Net effect= -(b+d)o b+d= deadweight loss due to tariffs

o other losses due to tariffso deadweighto production loss- b- increase in marginal costs for extra units produced o consumption loss- d- drop in consumer surplus for those who can no

longer consume the units between d1 and d2 because of the higher price

o Why tariffs?o Developing countries need government revenueo Political- benefits to producers are more concentrated on specific

firms and states than the cost to consumers which are nationwideo WTO

o Has a dispute settlement procedure if countries violate WTO rules.o Use of tariffs by an importer can easily lead to a response by exporters

and a tariff war

o Effect of the tariffo –(a+b+c+d) fall in consumer surpluso “a” rise in producer surpluso rise in government revenue +(c+e)o Net effect on home welfare e-(b+d)o E is the terms-of-trade-gain for the importer

o Foreign export supplyo Tariffs initially increase the importers welfare because of terms of

trade gain exceeds deadweight losso If the tariff is too large, the welfare decreases, possibly back to below

the free trade levelo A prohibitive tariff with no imports forced the importers welfare to be

at the no trade level. o Import quota

o Quota rents are the differences between world price and at home price (the profit made by importing)

1. Quota licenses given to home firms “c”. net effect –(b+d)2. Rent seeking – produce excess amounts of good to get import licenses

for the following year. This is inefficient and leads to welfare loss of –(b+c+d)

3. Auctioning the quota. Government of the importing country can auction off quota licenses. Effect is –(b+d)

4. Voluntary export restraint- the government of the importing country to give authority for implementing the quota to the government of the exporting country. –(b+c+d)

Chapter 8o Discriminating monopoly- charges a lower price to home than to firms in its own

local market therefor dumping its product into the home marketo A tariff applied against the foreign discriminating monopoly is called an

antidumping dutyo Infant industry- an industry o Market power- tariffs and quotas affect the trade equilibrium differently because

of their impact on the homes monopoly market power (the extent to which a firm can choose its price)

o Tariff- with a tariff the home monopoly will compete against a large number of importers, limiting market power

o Quota- once quota is reached the monopolist is the only producer able to sell in the home market.

o Tariffs allow the home firm to raise its price to p+t and net effect of –(b+d)o Quotas lead to higher prices for home customers since it allows monopolist to

keep market powero WTO encouraged countries to replace tariffs with quotao Home tariff

o Foreign monopoly- tariffs causes the foreign firm to pnew=pold-tariff Home welfare +(e+d)

o Firms can charge more and differentiate their prices in home and foreign markets. Price discrimination- firms can choose how much different groups pay

o Discriminating monopoly- monopolist is able to charge different prices in the two markets

o Equilibrium condition- for the discriminating monopoly profits are max MR=MR*=MC*

o Antidumpingo Under the rules of the WTO, an importing country is entitled to apply an

antidumping tariff any time that a foreign firm is dumping its product. o An imported product is being dumped if its price is below the price that

the exporter charges in its own local market.o Sometimes firms raise price to avoid antidumping laws

o Infant industry protectiono a tariff today leads to an increase in Home output that, in turn, helps the

firm learn better production techniques and reduce costs in the future.o import protection is potentially justified is when a tariff in one period

leads to an increase in output and reductions in future costs for other firms in the industry, or even for firms in other industries. This type of externality occurs when firms learn from each other’s successes

o mimic the successful innovations of other firms, and benefit from a knowledge spillover

o the infant industry argument supporting tariffs or quotas depends on the existence of some form of market failure.

Chapter 9o The reduction in the price received by exporters is a terms-of-trade gain for

the importing country. o two or more countries apply tariffs against each other in an attempt to

capture this terms-of-trade gain, they both end up losing. International agreements to reduce tariffs and move toward free trade are needed

o The WTO is a multilateral agreement, involving many countries, with agreement to lower tariffs between all the members.

o There are also smaller regional trade agreements, involving several countries, often located near each other.

o When countries seek to reduce trade barriers between themselves, they enter into a trade agreement—a pact to reduce or eliminate trade restrictions.

o most favored nation principle of the WTO, the lower tariffs agreed to in multilateral negotiations must be extended equally to all WTO members

o The Nash equilibrium in this case leads to an outcome that is undesirable for both countries even though it is the best outcome for each country given that the other country is imposing a tariff.

o preferential trade agreements, to emphasize that the member countries are favored over other countries

o free-trade area is a group of countries agreeing to eliminate tariffso customs union-similar to free trade but countries agree to a common

schedule of tariffs with other non union countrieso Rules of origin- determined which goods can be shipped duty free

within a free trade area.o International trade

o trade creation, occurs when a member country imports a product from another member country that formerly it produced for itself.

o trade diversion, which occurs when a member country imports a product from another member country that it formerly imported from a country outside of the new trade region.

o labor standards to refer to all issues that directly affect workers, including occupational health and safety, child labor, minimum wages, and so on.

o Living wage is a wage above the norm in the developing countryo multilateral environmental agreements, deal specifically with the

environmento tragedy of the commons

o Economists believe that this outcome occurs whenever people are competing for the same resource stock

o common property that anyone can harvest, it will be subject to overfishing and its stocks will diminish rapidly over time as each producer seeks to maximize its own share of the resource.

o