Consider a model of product differentiation and economies of scale. When such an economy is open...

Consider a model of product differentiation and economies of scale. When such an economy is open to free trade, what may be the effects on production, consumption, and export/import? How may its welfare change? (You do not need to give the details of the model. Focus on the intuition.) What are the sources of gain/loss? Under what conditions would the economy gain from free trade?

Expert Solution

Economies of scale models are used to explain trade among countries have similar technologies, similar endowments, and to some extent similar preferences. Monopolistic competition model is a model explains economies of scale and differentiated products when there are no differences in resources or technologies across countries. Its focus is on consumer demand. Monopolistic competition model helps to differentiated products when countries are very similar in their productive capacities.

When a large exporting country implements a trade policy it will affect the world market price for the good. Free trade increases the number of varieties of products for consumers to choose from, reduces the price of every variety sold in the market, increase the supply of products in other markets and result in lower prices for those products. I f the consumers purchase the product varieties over time, then free trade will increase the number of varieties available to each consumer, trade will improve every consumer’s welfare. Free trade induces a positive production efficiency effect. Improvements in productive efficiency arise as firms produce further down along their average cost curves in free trade. Consumption efficiency is raised because consumers are able to buy the products at lower prices and have a greater variety to choose from. Free trade increases allowing consumers to buy more, better-quality products at lower costs, drives economic growth, enhanced efficiency, increased innovation, and the greater fairness that accompanies a rules based system. Overall free has a positive effects on production, consumption, and export/import.

Welfare focuses on the optimal allocation of resources and goods. The purchasing power in both countries would rise in moving to free trade. Every worker will be able to buy more of goods, every one in both countries will benefits from free trade.

Gains from free trade refer to net benefits to a country from lowering barriers to trade such as tariffs on imports. International trade helps to increase the GDP of a country and also reduces the cost of products for the citizens of the countries receiving it. Sources of gain/loss in free trade are increased exports, increased competition, trade is an engine of growth, use of surplus raw materials.

Free trade lower prices for consumers, increased exports, benefits from economies of scale and a greater choice of goods. Free trade reduces imported input costs, reducing businesses production costs and promoting economic growth. Free trade improves efficiency and innovation. Economic resources include land, labor and capital. Free trade agreements ensure small nations can obtain the economic resources needed to produce consumer goods or services. Free trade improves the quality of life for a nation's citizens. Nations can import goods that are not readily available within their borders. There are some conditions leads to economy gain from free trade are increased Economic Resources, Improved Quality of Life, Better Foreign Relations, Improved Production Efficiency etc.

Rahul Sunny answered 2 years ago

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