05 Jun Question Problem Set 4 This problem set will be due on June 18 in class
Question
Problem Set 4
This problem set will be due on June 18 in class
Monopolistic Competition Model
In a market characterized by monopolistic competition we have assumed that an individual firm
faces the following demand and cost functions:
1
= [ ( ? )]
= +
The variables are defined as in lecture slides.
(1). How does the firm choose its optimal price and quantity supplied? What is the condition tha
defines profit maximization in this case? Define the equilibrium price in terms of , , , and ? .
(2). Suppose that a firms does not take other firms prices as given but takes the number of firms
as given. How might you change the problem as it was set up in question (1)? You o not need to
solve this problem. You only need to discuss how the setup of the maximization problem and
the way of solving it would change.
(3). In your calculation in question (1), is price equal to marginal cost? Why? Under what
condition will price equal marginal cost?
(4). What is the equilibrium number of firms? What is the equilibrium price and scale of
production? Express all of these variables in terms of exogenous variables.
(5). How do , , change when increases? When increases? Explain using your analytical
results. In addition, provide a short and intuitive explanation of your results.
Consider two previous closed economies that open up to trade with each other. These two
countries have very similar (if not identical) factor endowments and productivity differences.
Assume that the market for all goods that they produce have an imperfect
competition/monopolistic competition structure.
(7). What are the source of gains from trade for these countries?
(8). Will the relative importance of intra-industry trade be high or low compared to the
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