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 trade
o Same as monopoly equilibrium
o 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 trade
o New firms enter shifting demand curve to the left and
becomes more elastic (flatter curve) .
o Long run equilibrium is Q when MR=MC
o Price equals average cost
o Zero monopoly profits
o No entry or exit
Monopolistic competition in the short run with free trade
o Home and foreign have the same, number of consumers,
technology, cost curvesNormally 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
zero
o 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, and
o The expansion in the overall number of varieties of
products available to consumers with trade, despite the
exit of some firms in each country.
NAFTAo USA- long run gains, expansion in varieties, fall in
consumer prices
o USA and Canada- Long run gains exceeded short run costs
o 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 equation
o Jan Tinbergen
o Countries with higher GDPs and are closer to each other
will have more trade.
Border effects
o Tariffs- taxes on imports
o Quotas- limits
o Administrative rules and regulations affecting trade- time it
takes to clear customs
o Geographic factors- share a boarder or not
o 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 identical
o Trade within same industries across countries because they
can sell to a larger market
o Firms have to lower prices than when there is no trade
o 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 competition
o Trade policy- government action meant to influence the amount
of international trade
o Gains from trade are unevenly spread across industries so the
government limits losses (or increases gains) from international
trade
o GATT- 1947- reduce barriers to international trade between
nations
o Same tariffs to all trading partners that are WTO members
o Tariffs may be imposed in response to unfair trade and
dumping
o Countries should not limit the quantity of goods and
services they import
o Countries should not declare export subsidies provided to
particular firms, sectors, or industries
o 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 welfare
o P becomes p+w
o 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 revenue
o Net effect= -(b+d)

b+d= deadweight loss due to tariffs

losses due to tariffs
deadweight
production loss- b- increase in marginal costs for extra
units produced
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
tariffs?
Developing countries need government revenue
Political- benefits to producers are more concentrated on
specific firms and states than the cost to consumers which
are nationwide

o
o other
o
o
o
o Why
o
o

o 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 tariff
o (a+b+c+d) fall in consumer surplus
o a rise in producer surplus
o 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 supply
o Tariffs initially increase the importers welfare because of
terms of trade gain exceeds deadweight loss
o If the tariff is too large, the welfare decreases, possibly
back to below the free trade level
o 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 8
o Discriminating monopoly- charges a lower price to home than to
firms in its own local market therefor dumping its product into the
home market
o A tariff applied against the foreign discriminating monopoly is called
an antidumping duty
o 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 power
o WTO encouraged countries to replace tariffs with quota
o 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 Antidumping
o 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 protection
o 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 others 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 9
o The reduction in the price received by exporters is a terms-oftrade 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 agreementa 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 tariffs
o customs union-similar to free trade but countries agree
to a common schedule of tariffs with other non union
countries
o 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

o
o
o
o

formerly imported from a country outside of the new trade

region.
labor standards to refer to all issues that directly affect
workers, including occupational health and safety, child labor,
minimum wages, and so on.
Living wage is a wage above the norm in the developing country
multilateral environmental agreements, deal specifically
with the environment
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