PART B: SHORT-ANSWER QUESTION (60MARKS)
• Answer ALL questions in Part B.
• Please show all workings. Round your answers to two decimal places.
• Fully label your graphs, if you are required to draw one.
• Questions in Part B carry marks as indicated.
B1.
Suppose that fixed costs for a firm in the air-conditioning manufacturing industry (start-up costs of factories, automation chain, etc.) are $6.9 billion, and that variable costs are $15,000 per finished air- con. Suppose that the air-con market is monopolistically competitive, and firms are identical. More firms increase competition, and so the market price falls as more firms enter the market, making the market price to be = 15,000 + 200/ , where represents the number of firms in the market. Assume that there are three countries in the world: Ascalonia, Bretonnia, and Carlia, with the market size being 400 million, 550 million, and 200 million, respectively.
a. Calculate the equilibrium number of firms in Ascalonia air-con markets in autarky.
b. What is the equilibrium price of automobiles in Ascalonia if there is no international trade?
c. Now suppose that the three countries join to form a free trade area, and assume no transportation costs. How many firms will there be in the combined market? What will be the new equilibrium price, and average cost for each air-con?
d. Suppose instead that a revolution now closed Carlia off from the rest of the world, so that the free trade area now only consists of Ascalonia and Bretonnia. Calculate the number of firms, the equilibrium price, and average cost for each air-con in this combined market.
e. (6 marks) Compare the number of firms, and the price that Ascalonian consumers pay for each air- con between the scenarios in (b), (c) and (d). In which scenario would Ascalonian consumers benefit the most, and explain why.
