Feenstra Taylor Econ CH06

6
1
INCREASING RETURNS Basics of Imperfect
Competition
TO SCALE 2
Trade under Monopolistic
AND IMPERFECT Competition
3
COMPETITION Empirical Applications of
Monopolistic Competition
and Trade
4
Imperfect Competition with
Homogeneous Products
5
Conclusions
Introduction
We will look at trade in golf clubs, a good that the

U.S. imports and exports in large quantities.
Many countries that sell to the U.S. are also

buying from the U.S.
The total value of imports is close to the total value of
exports.
Why does the U.S. export and import golf clubs to

and from the same countries?
We observe intra-industry trade.
A new explanation for trade will be discussed here.
2008 Worth Publishers International Economics Feenstra/Taylor 2 of 111

Introduction
Table 6.1 U.S. Imports of Golf Clubs, 2005

Introduction
Table 6.1 U.S. Exports of Golf Clubs, 2005

Introduction
We will look at a model of monopolistic

competition where goods are differentiated.
Gives a degree of market power
Firms tend to specialize because in monopolistic

competition we have increasing returns to scale
The imperfect competition model also predicts

that larger countries will trade more with each
other.
This is called the gravity equation.

Trade Under Monopolistic Competition
We begin this section with a few assumptions

Assumption 1: each firm produces a good that is similar
to, but differentiated from, the goods that other firms in
the industry produce.
Assumption 2: there are many firms in the industry.
Assumption 3: firms produce using a technology with

increasing returns to scale (decreasing AC, fig. 6.3).
Assumption 4: firms can enter and exit the industry

freely, so that monopoly profits are zero in the long run.

Figure 6.3

Numerical Example
Using the cost curve in figure 6.3, we get:
Fixed costs = $100
Marginal costs = $10/unit
Q VC=Q*MC TC=FC+VC AC=TC/Q

10 $100 $200 $20
20 200 300 15
30 300 400 13.3
40 400 500 12.5
50 500 600 12
100 1000 1100 11
Large Q 10Q 10Q+100 Close to 10

Equilibrium Without Trade

Short-Run Equilibrium
Figure 6.4 shows our monopolistically competitive firm.
Each firm maximizes profits by producing Q0, where MR=MC.
Price is from the demand curve at P0.
Since price is greater than average cost, the firm is earning
positive monopoly profits.
Long-Run Equilibrium
Since firms are making positive profits, firms will enter the
industry.
The demand for existing firms will fall until no firm is earning
positive profits; the demand curves also becomes flatter (more
elastic).
Figure 6.4
Price
Short run equilibrium here is the same as

for a monopolist. MR = MC with price from
demand. Since P > AC, firm is making a
profit.
P0
AC
MC
Demand curve
mr0 facing each firm, d0
Q0 Quantity

Figure 6.5
Price Drawn by the profits in the industry, firms
enter. The demand for this firm drops to d1
Equilibrium is at A, producing Q1,
with corresponding mr1. d1 is more elastic,
where mr1 crosses MC. This gives
due to competition, and therefore flatter
price, PA, from the demand, d1
than d0
P0 At Q1, the no-trade price PA = AC so the

firms are all earning zero monopoly profits
and there is no entry or exit
PA A
AC
MC
d1
mr1 d0 Firm demand when all firms
D/NA charge the same price
Q1 Q0 Quantity

Equilibrium With Free Trade
Assume Home and Foreign are exactly the same.
Same number of consumers
Same technology and cost curves
Same number of firms in the no-trade equilibrium (NA)
If there were no economies of scale, there would be no reason for

trade.
Short-Run Equilibrium with Trade

When trade opens, the number of customers available to each firm
doubles, but the number of product varieties available to each
consumer also doubles.
With the greater number of varieties available, the demand for
each individual variety will be more elastic.

Short-Run Equilibrium with Trade

After trade, demand is no longer tangent to the AC.
Each firm now produces at Q2 charging P2.
Firms are making positive monopoly profits.
This shows the firms incentive to lower its price
Every firm in the industry has the same incentive.
If all firms lower prices, though, the quantity demanded

from each firm increases along D/NA, instead of d2.
Remember D/NA is the demand if all firms had the same price.
In the short run, firms lower their prices expecting to

make profits at B, but end up with losses at B.
Figure 6.6
Price
Opening
As trade
all firms makes
lower their the firms
price to Pdemand even more
2, the relevant demand
is D/N at
elastic,A B selling
shown by d2only
. The Qfirm
2. Atchooses
this point
to firms are at Q2,
produce
incurring
where MR=MC,losses and some
selling at Pfirms
2. At will
thisbe forced
price the to exit
firm the
makes
industry
monopoly profits as P2>AC
Long-run equilibrium
without trade
Short-run equilibrium
with trade
PA A
P2 B
B d2
AC
MC
mr2
D/NA
Q1 Q2 Q2 Quantity

Long-Run Equilibrium with Trade

Since firms will exit the industry, increasing demand for
the remaining firms products and decrease the
available product varieties to consumers.
We now only have NT firms which is fewer than the NA

firms we had before.
The new demand D/NT lies to the right of D/NA.
Long-run equilibrium with trade is at point C.
The demand for each firm d3 is tangent to AC.

Figure 6.7
Price Since
Since some firms
PW = AC, have
firms exited the is
The demand faced byare making
each firm zero
d3
industry,
with mr3we
monopoly are=MC
. profits,
mr leftnowith T firms
firms
shows exit which
that or enter the
each
3
gives each
industry, firm
and
firm produces CQaisshare of the
the long runWdemand
equilibrium
3 at a price P
shown by D/N T
with trade
without trade
D/NT
PA A with trade
PW C
AC
d3
MC
mr3
Q1 Q3 Quantity

Long-Run Equilibrium with Trade

The world number of products is greater than the
number available in each country before trade.
Fewer firms remain in each country, but each is bigger.
As quantity increases, average costs fall due to
increasing returns to scale, therefore so do prices.
Gains From Trade

There are two sources of gains for consumers:
Price is lower after trade.
Consumers obtain higher surplus when there are more product
varieties from which to choose.

Adjustment Costs from Trade
There are adjustment costs as some firms shut down and
exit the industry.
Workers in those firms experience a spell of unemployment.
Over the long run however, we expect those workers to find

new positions.
Temporary costs
Compare short-run and long-run adjustment costs.
We will look at evidence form Mexico, Canada, and the U.S.

under the North American Free Trade Agreement (NAFTA).

Empirical Applications of Monopolistic
Competition and Trade
Gains and Adjustment Costs for Canada
The potential for Canadian firms to expand output was a key
factor in Canadas free-trade agreement with the U.S. in
1989 and entry into NAFTA (along with Mexico) in 1994.
Studies in Canada as early as the 1960s predicted

substantial gains from free trade with the U.S.
Firms would expand their scale of operations to service
the larger market and lower their costs.
Studies by Harris in the mid-80s influenced Canadian policy

makers to proceed with the free trade agreement with the
U.S.
The article described next looks at what happened in

Canada after the implementation of NAFTA.

What Happened When Two countries Liberalized Trade?
HEADLINES
Data from 19881996 was used by Daniel Trefler
of University of Toronto to estimate effects of the
Canada-U.S. Free Trade Agreement.
Some findings:
Short-run adjustment costs of 100,000 jobs, or 5% of
manufacturing employment.
Some industries that had very large tariff cuts saw
employment fall by as much as 12%
Over time, however, these job losses were more than
made up for by creation of new jobs elsewhere in
manufacturing.
There were no long run job losses due to NAFTA.

What Happened When Two countries Liberalized Trade?
HEADLINES
In the long run, large positive effects on
productivity were found.
15% over eight years in industries most affected by tariff cuts
compound growth of 1.9%/year.
6% for manufacturing overallcompound growth of 0.7%/year.
The difference of 1.2%/year is an estimate of how free trade with
the U.S. affected the Canadian industries over and above the
impact on other industries.
There was also a rise of 3% in real earnings over this period.
These findings support the monopolistic
competition model.

Gains and Adjustment Costs for Mexico
Joining NAFTA was a way to ensure the permanence of
economic reforms already underway.
Under NAFTA, Mexican tariffs on U.S. goods declined
from an average of 14% in 1990 to 1% in 2001.
In addition, U.S. tariffs on Mexican imports fell as well.
Productivity in Mexico (figure 6.8)

Panel A shows productivity over time.
Panel B shows what happened to real wages and real
income over time.

Figure 6.8

Productivity in Mexico
For the maquiladora plants, productivity rose 45% from
1994 to 2003compound growth rate of 4.1%/year.
For non-maquiladora plants, productivity rose overall by
25%compound growth rate of 2.5%/year.
The difference, 1.6%/year, is an estimate of the impact
of NAFTA on the productivity of maquiladora plants
over and above the increase in productivity that
occurred in the rest of Mexico.

Real Wages and Income
From 1994 to 1997, there was a fall of over 20% in real wages
in both sectors, even with increase in productivity. Why did it
happen?
Shortly after joining NAFTA, Mexico suffered a financial crisis

that led to a large devaluation of the peso.
Mexican CPI went up leading to a fall in real wages.
The decline was, however, short lived.

Real wages in both sectors began to rise again in 1998.
By 2003, real wages were almost back to their 1994 value.
Since real wages were not higher than in 1994, any

productivity gains from NAFTA were not shared with workers.

Real Wages and Income
If we look at real monthly income, the picture is a little
better.
This includes other sources of income beside wages, especially
for higher-income persons.
In the maquiladora sector, real incomes were higher in

2003 than in 1994.
Some gains for workers in plants most affected by NAFTA.
Higher-income workers fared better than unskilled

workers in Mexico.
Higher-income workers in the maquiladora sector are principal
gainers due to NAFTA in the long run.

Figure 6.8

Adjustment Costs in Mexico
When Mexico joined NAFTA, it was expected that the
agricultural sector would fare the worst due to
competition from the U.S.
Tariff reductions in agriculture were phased in over 15 years.
The evidence to date shows the corn farmers did not

suffer as much as was feared. Why?
The poorest farmers consume the corn they grow.
Mexican government was able to use subsidies to offset the
reduction in income for other corn farmers.
Total production of corn in Mexico rose following NAFTA.

Adjustment Costs in Mexico
Increasing volatility due to trade can be counted as
adjustment costs.
For maquiladora plants, employment grew rapidly
following NAFTA to a peak of 1.29 million in 2000.
After that, this sector entered a downturn.
The U.S. entered a recession decreasing demand for Mexican
exports.
China was competing for U.S. sales by exporting goods similar
to those sold by Mexico.
The Mexican peso became over-valued, making it difficult to
export abroad.
Employment in the maquiladora sector fell after 2000 to
1.1 million in 2003.

Gains and Adjustment Costs for the U.S.
Studies on the effects of NAFTA on the U.S. have not
estimated its effects on the productivity of U.S. firms.
It would be hard to identify the impact since Mexico and
Canada are only two of many trading partners.
Instead, researchers have estimated the second source
of gains from trade: the expansion of import varieties
available to consumers.
For U.S. we will compare the long-run gains to
consumers due to expanded product varieties with the
short-run adjustment costs from exiting firms and
unemployment.

Expansion of Variety to the U.S.
To understand how NAFTA affected the range of products
available to U.S. customers, we will look at imports from
Mexico in 1990 and 2001.
Focus on the number of different types of products Mexico
sells to the U.S. compared to the total the U.S. imports from
all countries.
Table 6.3 Mexicos Export Variety to the United States

Expansion of Variety to the U.S.
According to one estimate, the total number of product
varieties imported into the U.S. from 19722001 has
increased four times.
That expansion in import variety has had the same
effect as a reduction in import prices of 1.2% per year.
Using an average $90 billion in U.S. imports per year
and the 1.2% reduction in prices to U.S. consumers,
$90(1.2%) = $1.1 billion per year in savings to
consumers.
These consumer savings are permanent and increase
over time as export varieties grow.
In 2003, the 10th year of NAFTA, consumers would gain
$11 billion as compared to 1994.
Adjustment Costs in the U.S.
These come as firms exit the market due to import competition and
the workers employed there are temporarily unemployed.
One way to measure this loss is to look at claims under the U.S.
Trade Adjustment Assistance (TAA) provisions.
From 19942002, about 525,000 workers, or about 58,000 per

year, lost their jobs and were certified as adversely affected by
trade under the NAFTA-TAA program.
Compare to the annual number of workers displaced in

manufacturing or 444,000 workers per year.
The NAFTA layoffs of 58,000 workers were about 13% of total

displacementthis is a substantial amount.

Adjustment Costs in the U.S.
Another way to measure effects is to compare the loss in
wages from the displaced workers to the consumer gains.
Suppose the average length of unemployment for laid off

workers is 3 years.
Average yearly earnings for manufacturing workers was

$31,000 in 2000 so each displaced worker lost $93,000 in
wages. total losses were $5.4 billion.
These private costs of $5.4 billion are nearly equal to the

average welfare gains of $5.5 billion.
However, gains continue to grow over time and job loss was
only temporary.
Summary of NAFTA
We have been able to measure in part the long-run
gains and short-run costs from NAFTA for Canada,
Mexico, and the U.S.
It is clear that for Canada and the U.S., the long-run

gains considerably exceed the short-run costs.
In Mexico the gains have not been reflected in the

growth of real wages for production workers.
The real earnings for higher-income workers in the

maquiladora sector have risen and have been the
principal beneficiaries of NAFTA so far.

Intra-Industry Trade
Countries will specialize in producing different varieties
of a differentiated good and will trade those varieties
back and forth.
The index of intra-industry trade tells us what

proportion of trade in each product involves both
imports and exports.
100 = equal quantities of exports and imports
0 = only exports or imports
Min of Imports & Exports

Index of IIT
1 Exports Imports
2
Index of Intra-Industry Trade
For the golf clubs, we can use data from Table 6.1.
The minimum of imports and exports is $305.8.
Using the other data, we have
Index of IIT = 305.8/[.5(305.8+318.7)] = 98%.
In Table 6.4 there are other examples of intra-industry
trade in other products for the U.S.
To obtain a high index of intra-industry trade, it is
necessary for the good to be differentiated and for
costs to be similar in the Home and Foreign countries,
leading to both imports and exports.

Table 6.4 Index of Intra-Industry Trade for the U.S.

The Gravity Equation
To explain the value of trade, we need a different equation
called the gravity equation.
Dutch economist and Nobel laureate, Jan Tinbergen was

trained in physics and thought the trade between countries
was similar to the force of gravity between objects.
Objects with larger mass or those that are close together have
greater gravitational pull between them.
The force of gravity between these two masses is:

Fg = G[M1M2/d2]
G is the constant that tells the magnitude of the relationship.
M1 and M2 are the two objects masses.

The Gravity Equation in Trade
We use a similar equation to measure the trade
between two countries.
Instead of mass, we use the GDP of each country.
The distance still matters, but we are not sure of the

precise relationship between distance and trade.
There is also a constant term that indicates the

relationship between the gravity term and trade.
GDP1 GDP2
Trade B
dist n
The Gravity Equation in Trade
The constant term can also be interpreted as
summarizing the effects of all factors, other than
distance and size, that influence the amount of trade
between two countries.
The effect of size is an implication of the monopolistic

competition model we studied in this chapter.
Larger countries export more because they produce more
product varieties, and import more because their demand is
higher.

Deriving the Gravity Equation
Start with Country 1, which produces a differentiated
product.
Other countries demand for Country 1s goods depends on:
The relative size of the importing country
The distance between the two countries
Relative size, is a countrys share of world GDP.
Share2 = GDP2/GDPw
Exports from Country 1 to Country 2 will equal the goods
available in Country 1 times the relative size of country 2,
divided by the transportation costs:
GDPShare 1 1 2
GDPGDP 1 2
Trade = = n n
dist GDP W
dist
The Gravity Equation for Canada and the United States
APPLICATION
Figure 6.9 shows data collected on the value of trade

between Canadian provinces and the U.S. states in 1993.
An exponent of 1.25 is used on the distance variable

based on other research studies.
The horizontal axis is the log of the gravity equation The

higher the value means either a large GDP for the trading
province and state or a smaller distance between them
The vertical axis shows the 1993 value of exports

between a Canadian province and U.S. state or vice
versa, again in logarithms.

APPLICATION
Each of the points in panel A represents the trade flow and

gravity term between one state and one province.
We can see that a pair with a high gravity term also has
more trade.
This supports the gravity equation theory.
We can also estimate a best fit line through the data points
which gives a constant term of 93.
When the gravity term equals 1, then the predicted amount of trade
between that state and province is $93 million.

APPLICATION Figure 6.9

Trade with Canada
APPLICATION
The gravity equation should also work well at predicting
trade within a country, or intra-national trade.
Panel B of figure 6.9 graphs the value of exports and the

gravity term between any two Canadian provinces.
There is a strong positive relationship between the gravity

term between two provinces and their trade.
The best fit line gives a constant term of 1300.

When gravity term is 1, the predicted amount of trade is $1.3
billion.

Trade with Canada
APPLICATION Figure 6.9

Trade with Canada
APPLICATION
Taking the ratio of the constant terms (1300/93 = 14),
means on average there is 14 times more trade within
Canada than occurs across the border.
The number is even higher if we consider an earlier year

before the free trade agreement.
In 1988, intra-national trade within Canada was 22 times higher.
The fact that there is so much trade within Canada reflects

all the barriers to trade that occur between countries.
Tariffs and Quotas
Other administrative rules and regulations
Geographic an cultural factors

Imperfect Competition with Homogeneous
Products: The Case of Dumping
While product differentiation is a good assumption for
many goods, it does not hold for unprocessed goods
traded between firms.
Chemicals, lumber, minerals, steel, can all be treated as
homogeneous.
However, in many of these goods, the markets are not

perfectly competitive.
We want to assume imperfect competition here even though the
goods are homogeneous.
With imperfect competition, firms can charge different

prices across countries and will do so whenever it is
profitable.

A Model of Product Dumping
Dumping occurs when a firm sells a product abroad at
a price that is either less than the price it charges in its
local market, or less than its average cost to produce
the product.
Under the rules of the WTO, am importing country is

entitled to apply a tariff, called an antidumping duty
any time a foreign firm dumps its product on a local
market.
Why do firms dump at all?

Discriminating Monopoly
Assume a foreign monopolist sells both to its local
market and exports to Home.
The monopolist is able to charge different prices in the

two markets.
Discriminating monopoly
Firm has a monopoly at home but faces a competitive

export market
Downward sloping demand curve in home market.
Horizontal demand curve in export market.
Consider the following example:

Figure 6.10
The
Thequantity sold in the
export monopoly
Price local market profits
maximizes is at point
at
The monopolist sells Q2 to its
MC* C where local marginal
point B where local
local market and (Q1-Q2) to
costs, MC*,costs,
marginal equalMC*,
local
its export market
marginal revenues,
equal export marginal
MR*.
revenues, MR then
They can
Local charge a local price, P*,
Price, P* from the local demand
curve
Notice the local price, P*, is greater
than AC*; but, the export price, P, is
less than AC*. This means the firm
AC*
is dumping into the export market
AC1
Export Export Demand, D, and export
Price, P marginal revenue, MR
C B
Local Marginal Local

Revenue, MR* Demand, D*
Q2 Q1 Foreign Quantity
Local Sales Exports

The Profitability of Dumping
The Foreign firm charges P* selling Q2 in the local
market.
The local price is higher than the export price.

It is dumping its product into the export market.
The average costs are lower than the local price but
higher than the export price.
Since AC is above the export price, the firm is also

dumping according to this cost comparison.

Numerical Example of Dumping
Suppose the following data:
Fixed costs = $100; Marginal costs = $10/unit
Local price = $25; Local quantity = 10
Export price = $15; Export quantity = 10
Profits from the local market are:

$25(10) - $10(10) - $100 = $50
Average costs for the firms are $20.

Profits in the export market are:
[$25(10) + $15(10)] - $10(20) - $100 = $100
The export price is below AC but above MC.

Reciprocal Dumping
It can happen that firms in both countries are accused
of dumping in the otherthis is reciprocal dumping.
For example, shortly after the U.S. ruled that Canadian

greenhouse tomatoes were being dumped into the
U.S., the Canadian government investigated dumping
against American fresh tomatoes.
The final ruling was that there was no harm or injury to

the firms in either country, so no antidumping duties
were applied.

Reciprocal Dumping
How can it be profitable for both firms to charge prices
for their exports that are below their local prices?
We show that, in fact, it is a common feature of
imperfectly competitive markets.
Rather than selling additional units in the local market
and depressing its own price, a firm can enter the
export market.
It then depresses the price of firms abroad by
increasing quantity.
Since both firms have this incentive, equilibrium will
have both firms selling abroad.
Numerical Example of Reciprocal Dumping
Assume Home and Foreign have identical demand
curves: P = 100 Q
Remember, marginal revenue, MR = P P*Q
The price drops $1 for even extra unit sold, so P=1

and MR = P-Q, this gives:
MR = P Q = (100 Q) Q = 100 2Q
Home and Foreign have identical MC = $20/unit.
Without trade, we get the monopoly equilibrium

Q = 40 and P = $60

Figure 6.11
As with any monopoly, each firm will choose their profit maximizing output where
MR=MC and get their price from the demand curve: Q=40 and P=$60. For the
firm to increase production would require lowering price, which is not profitable.
(a) Home (b) Foreign

Price Price
No-trade No-trade
monopoly monopoly
equilibrium equilibrium
A A*
$60
$20 MC
D D*
MR MR*
40 Quantity 40 Quantity

Trade Equilibrium in the Home Market
Foreign has an incentive to export to Home (since price is
still above marginal cost and doing so depresses price for
the other firm).
The Foreign firm will export more than one unit since the
MR>MC.
We can use the equilibrium condition (MR=MC) from before

to determine how much will be exported.
In this case we will assume there are transportation costs for

the exports of $10 per unit, so the equilibrium condition is:
$20 + $10 = P QF
QF = P - $30

Trade Equilibrium in the Home Market
In response to the price decline, the Home firm will reduce the
quantity it produces in Home.
Home firm will choose the Home quantity by comparing MR to MC

in the Home market:
QH = P - 20
The price in the Home market is related to the total quantity sold:
P = 100 Q = 100 QF QH
Using the profit maximizing conditions and the demand equation,

we get:
P = 100 (P - $30) (P - $20) = $50
The equilibrium price with trade is $50. Home produces 30 for

domestic market and 20 for Foreign.
Two-way Trade
Since the Foreign firm has an incentive to enter the
Home market and both firms are the same, the Home
firm has the same incentive in the Foreign market.
Foreign price with trade will also be $50 with Foreign

producing 30 units for its own market and importing 20
units from Home.
B and B* in figure 6.11
Notice that as each firm sells in the other market, prices

fall in both market. Firms are engaged in reciprocal
dumping

Figure 6.11
From theequal
Exports previous derivation,
imports for bothwe sawand
Home thatForeign
equilibrium
fromwith
eachreciprocal
dumping
other will occur Dumping
Reciprocal at points B and B*, at a price of $50 selling 50.
Each country will have 30 in local sales and export 20.
Price (a) Home Price (b) Foreign
No-trade No-trade
monopoly monopoly
equilibrium equilibrium
A A*
$60
B B*
$50
$20 MC
D D*
MR MR*
30 40 50 Quantity 30 40 50 Quantity
Local Exports= Reciprocal Dumping

Local Exports=
Sales Imports Sales Imports

Measurement of Dumping
In trade disputes over dumping, the government in
each country compares the price that a Foreign firm
earns in the countrys market, net of transportation
costs, to the price the Foreign firm earns in its local
market.
In our example, Foreign exports at $50 with $10 in
transportation costs: net $40.
Since the price in local market is $50, Foreign is
dumping in the Home market.
Similarly, Home is dumping into the Foreign market.
Reciprocal dumping is occurring.
Measurement of Dumping
This example has allowed us to illustrate the incentives
for firms to enter markets abroad.
For the first units sold to the export market, the MR for
the exporting firm will always be higher than the MR of
the local firm abroad.
The exporting firm does not lose as much revenue from existing
sales by selling additional units in the export market.
The Foreign firm has an incentive to enter the Home

market and the Home firm has an incentive to enter the
Foreign market.
We should not be surprised to see two-way trade even
with homogeneous products.

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6

We will look at trade in golf clubs, a good that the

Many countries that sell to the U.S. are also

Why does the U.S. export and import golf clubs to

2008 Worth Publishers International Economics Feenstra/Taylor 2 of 111

2008 Worth Publishers International Economics Feenstra/Taylor 3 of 111

2008 Worth Publishers International Economics Feenstra/Taylor 4 of 111

We will look at a model of monopolistic

Firms tend to specialize because in monopolistic

The imperfect competition model also predicts

2008 Worth Publishers International Economics Feenstra/Taylor 5 of 111

We begin this section with a few assumptions

Assumption 2: there are many firms in the industry.

Assumption 3: firms produce using a technology with

Assumption 4: firms can enter and exit the industry

2008 Worth Publishers International Economics Feenstra/Taylor 6 of 111

2008 Worth Publishers International Economics Feenstra/Taylor 7 of 111

Q VC=Q*MC TC=FC+VC AC=TC/Q

2008 Worth Publishers International Economics Feenstra/Taylor 8 of 111

Equilibrium Without Trade

Short run equilibrium here is the same as

2008 Worth Publishers International Economics Feenstra/Taylor 10 of 111

P0 At Q1, the no-trade price PA = AC so the

2008 Worth Publishers International Economics Feenstra/Taylor 11 of 111

If there were no economies of scale, there would be no reason for

Short-Run Equilibrium with Trade

2008 Worth Publishers International Economics Feenstra/Taylor 12 of 111

Short-Run Equilibrium with Trade

Every firm in the industry has the same incentive.

If all firms lower prices, though, the quantity demanded

In the short run, firms lower their prices expecting to

2008 Worth Publishers International Economics Feenstra/Taylor 14 of 111

Long-Run Equilibrium with Trade

We now only have NT firms which is fewer than the NA

The new demand D/NT lies to the right of D/NA.

Long-run equilibrium with trade is at point C.

The demand for each firm d3 is tangent to AC.

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Long-Run Equilibrium with Trade

Gains From Trade

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Workers in those firms experience a spell of unemployment.

Over the long run however, we expect those workers to find

Compare short-run and long-run adjustment costs.

We will look at evidence form Mexico, Canada, and the U.S.

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Studies in Canada as early as the 1960s predicted

Studies by Harris in the mid-80s influenced Canadian policy

The article described next looks at what happened in

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Productivity in Mexico (figure 6.8)

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Shortly after joining NAFTA, Mexico suffered a financial crisis

The decline was, however, short lived.

Since real wages were not higher than in 1994, any

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In the maquiladora sector, real incomes were higher in

Higher-income workers fared better than unskilled

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