Lecture 5 - Monopolistic Competition Flashcards
(11 cards)
Why might increasing returns to scale in production incentivize the concentration of production in a limited number of locations?
Increasing returns to scale means that setting up and maintaining production involves significant fixed costs.
By concentrating production in fewer locations, a firm avoids paying these fixed costs multiple times.
What is the condition for equilibrium under monopolistic competition related to average cost?
In a monopolistically competitive equilibrium, Average Revenue must equal Average Cost (P = AC) due to free entry driving profits down to zero.
What are the three distinctive features of monopolistic competition as modeled by Chamberlin (1933)?
The three distinctive features are:
(1) Each firm faces a downward-sloping demand curve (market power)
(2) There are a large number of firms such that a single firm’s price change doesn’t affect others’ demand,
(3) There is free entry driving profits to zero.
According to Krugman’s (1979) model, why might two countries with identical technologies and preferences still engage in trade when opening their economies?
Even with identical technologies and preferences, trade can occur due to economies of scale, which incentivize concentrating production and then trading to access a wider variety of goods.
In Krugman’s (1980) model with CES preferences, what is the key characteristic of the elasticity of demand for a firm’s product when the number of firms is large?
For a large number of firms, the elasticity of demand approaches the constant elasticity of substitution (s) and does not vary with the firm’s output.
What are the two key equilibrium conditions for monopolistic competition used to derive the PP and ZZ curves in Krugman’s (1979) model?
The two equilibrium conditions are: MR = MC (leading to the PP curve) and Average Revenue = Average Cost or P = AC (leading to the ZZ curve).
What is the key difference in consumer preferences between Krugman’s 1979 model and his 1980 model, as presented in the source?
The 1979 model uses general variety-loving preferences (Dixit-Stiglitz U = Σ v(c_i) with v’ > 0, v’’ < 0).
The 1980 model uses a specific form of these preferences called Constant Elasticity of Substitution (CES), where U = Σ c_i^((s-1)/s) with s > 1 being the elasticity of substitution
In the Krugman (1979) model under autarky, what does the “ZZ curve” represent?
The Zero-Profit (ZZ) curve.
It shows the relationship between the real price and output (or consumption) that yields zero profits, which is where Price equals Average Cost (p/w = a/xi + b)
In the Krugman (1979) model, how is the equilibrium number of firms (n) determined under autarky?
Given the equilibrium output per firm (x) found from the PP and ZZ intersection, the total labor force (L) must be fully employed by these firms.
Since each firm uses a + bx labor, the total labor is n * (a + bx). Setting this equal to L gives n = L / (a + bx)
How does assuming CES preferences in Krugman’s (1980) model affect the equilibrium output per firm (y)?
With a fixed markup over marginal cost, the output at each firm is also fixed at a constant value (y = (s-1)a/b). This output does not change when the economy opens to trade.
Based on the empirical implications summarized from the Krugman models, what happens to the number of product varieties produced within each country when trade opens?
Trade reduces the number of products produced in each country (“shake-out”)
