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1

2 assumptions in neoclassical theory

1. Perfect Competition
2. Constant returns to scale implied by unit factor requirements.

2

In new Trade theory, gains from trade are due to....

IRS/EOS

3

2 assumptions in new Trade theory

1. Imperfect competition
2. IRS

4

Internal Eos =

AC fall as output of a FIRM rises

5

External Eos =

AC fall as INDUSTRY output rises

6

Example of British industry reliant on bigger market

British car industry
Most cars produced in uk exported to eu - bigger market allows uk producers to increase output —> IRS
most inputs imported from eu

7

I’m perfect competition, what does the demand curve look like and why?

Perfectly ELASTIC - horizontal demand curve
Demand = MR - can sell as much as you want without lowering price
Price takers - a firm cannot influence price by changing their output.

8

Optimality condition for monopoly

MR=MC gives Q*
Go up to demand curve to find P*

9

What’s a big characteristics if imperfect competition? Why?

demand slopes DOWN and MR BELOW demand curve.
Without price discrimination, must decrease price to sell at extra unit.
But cannot discriminate so much decrease price for all existing units.
Hence MR < demand which gives price.

10

Profit calculation

Pi = (P - AC) x Q

11

Which curve shows IRS and how?

AC downwards sloping so that AC fall as Q rises

12

How do AC and MC relate graphically?

AC above MC due to fixed costs.

13

Total costs (C) =

C = F + cQ
Total costs = fixed costs + variable costs

14

Why do we still have IRS even with a constant MC?

Due to the fixed element of costs

15

Basic AC formula

AC = C/Q = F/Q + c

16

When do we have CRS even under imperfect competition?

If F=0 I.e. no fixed costs, AC = c

17

Degree of competition in monopolistic competition

NOT perfectly competitive due to PRODUCT DIFFERENTIATION

18

What does product differentiation mean?

Each firm produces a unique variety of the same good.
Good, but not perfect substitutes.
Small differences like branding, colour etc.

19

What’s the technology assumption for monopolistic competition?

SAME TECHNOLOGY - firms' varieties only have trivial differences, but are the same quality.

20

Monopolistic firms behave....

AS IF they were monopolists

21

2 assumptions for monopolistic model

1) no strategic interaction
2) free entry

22

Give the general demand function Q for monopolistic

Q = S[1/n - b(P - Pbar)]

23

What does b measure in the demand function? (2)

b = how responsive demand is to price
Exactly PED if we take logs.
It can also measure degree of product differentiation - lower b = more inelastic = product more differentiated.

24

What is the important assumption about monopolistic firms?

SYMMETRIC FIRMS
- identical demand functions
- identical cost functions & production technology
But not identical due to product differentiation.

25

2 implications of the symmetry assumption

P = P bar - firms charge the same price in equilibrium
Q = S/n - each firm produces an equal share of total industry output.

26

Write AC as a function of n

AC = F/Q + c
Q=S/n
—> AC = F(n/S) x c

27

How are AC affected by n and S?

AC = F(n/S) + c
Higher n = each firm can produce less = higher AC
higher S = each firm can produce more = lower AC

28

Outline steps to find the price schedule

1. Find MR by dR/dQ
2. Set MR=MC
3. Sub in monopolistic demand function Q=S/n

29

Find MR

R=PQ
Assume linear demand for simplicity first: Q = A - BP
R = Q(A - Q / B)
dR/dQ = A/B - 2Q/B
A/B= P + Q/B from inverse demand
—> MR = P - Q/B

30

Set MR = MC and sub in monopolistic demand to get final price schedule formula in terms of n.

P - Q/B = c
Q=S/n and B=Sb
—> P = c + 1/nb