Q. There are two countries- home and foreign. Suppose that the production of vacuum cleaners exhibits external economies of scale. Average costs at home are AC= 110-Q and in foreign, average costs are AC*=120-Q*. World demand is Q=100-P/2.
a) If the foreign country enters the market first, determine the equilibrium price and quantity? Will both countries produce? Show both average cost curves and the equilibrium in a graph.
b) Which country would consumers prefer that vacuum cleaners be produced? Is this the country that produces in equilibrium in part a?
c) Suppose the home country imposes a specific tariff to protect its vacuum cleaners. How large would the tariff need to be to induce domestic production (assume the tariff does not impact the world price)? What does this say about the "stickiness" of patterns of trade that result from external economies of scale?
d) Assume now that there is a cost reduction in home country, so that the average cost becomes AC=35- (7/22)Q. Does this change the equilibrium outcome? How many vacuums do foreign produce? How many vacuums does home produce? At what price? Graph this outcome.