Question

Economies of scale are important because they mean that as firms increase in size, they can become more efficient. What is meant by product differentiation and intra-industry trade? Consider the intra-industry trade model under the assumptions of monopolistic competition. (See the class notes)

a. Draw two graphs showing long-run equilibrium of a firm under autarky, and the long-

    run equilibrium of a firm with trade.

b. How do the countries gain from the intra-industry trade?

Answer 1

Through Product differentiation, a firm showcases the differences between products. Differentiation looks to make a product more attractive by contrasting its unique qualities with other competing products. Successful product differentiation creates a competitive advantage for the product's seller, as customers view these products as being unique or superior.

Intra-industry trade refers to the exchange of similar products belonging to the same industry. The term is usually applied to international trade, where the same types of goods or services are both imported and exported.

a.

In graph A, long run autarky equilibrium is A

In graph-B, long run trade equilibrium T

b. Countries gain from the intra industry trade by the following ways:

1. Intra-industry trade increases the variety of products the same industry, which is beneficial to both, businesses, as well as consumers.

2. It gives opportunity for businesses to benefit from the economies of scale, as well as use their comparative advantages.

3. Intra industry trade also stimulates innovation in industry and assist the economy in cases of short-term economic fluctuations

Intra-industry trade has evolved to be one of the important macro-economic practices that is beneficial in terms of maintaining macro-economic stability, promoting innovation and increasing the number of differentiated versions of the same type products in markets of the trading partner countries.