The Intra-Industry Trade Model
1) Explain the Krugman Imperfect Competition Model of intra-industry trade in automobiles, and what the model means. Use diagrams to demonstrate the model in autarky and in free trade, and to show the existence of gains from trade.
The two main equations of the Imperfect Competition in Trade Model for automobiles are:
Average Cost:
Price-Competition:
where F = fixed cost = $750,000,000
Q = sales of an individual firm
S = total sales of the industry ()
c = marginal cost = $ 5500
b = a parameter of the demand equation = 1 / 30,000
n = number of firms in the market
P = price per car
AC = average cost per car
2) Home Country: Given that the total market of the Home country is 900,000 units. Given the equations and parameter values above, solve for the equilibrium number of automobile companies, the number of cars each firm will produce, and the price of the cars in the Home country. Draw a diagram illustrating the model.
3) Foreign Country: Given that the total market of the Foreign country is 1,600,000 units. Given the equations and parameter values above, solve for the equilibrium number of automobile companies, the number of cars each firm will produce, and the price of the cars in the Home country. Draw a diagram illustrating the model.
4) Free Trade: Now combine the two economies together in free trade. Now what are the results? How many firms and varieties of automobiles are there available? What is the price of the cars? Draw a diagram illustrating the model. What happened in the industry in free trade? Are consumers better off? Are there any gains from trade? What are they? Why?