Essay A. (30 points) Suppose that two countries want to integrate their automotive
industries where firms (GM, Toyota, Ford, Audi and etc) are competitive
monopolists. We know that the average cost faced by each firm is described by AC =
Fn/S + c, where n represents the number of firms in the market, F represents the fixed
costs of production, S represents the total sales, and c represents the marginal cost. We
also know that equilibrium prices can be described by P = c + (500/n), where P represents
the price. Suppose that the total sales of cars in the Home country is 17,000,000, while in
the Foreign Market is 3,000,000. Notice that the marginal cost c is equal to $10,000, and
fixed cost F equals $100,000,000.00. Using this information answer the following
a) Find the price and number of firms in each market when the economies do not trade.
b) Find the price and the total number of firms in the integrated (free trade) market. What
are the sources of gains from trade in this case?
c) Explain the difference between the market equilibrium in letters “a” and “b” using
graphical analysis. Relate the distribution of gains from trade to the size of the
d) How do your answers in letters “a-c” relate to the North American Auto Pact of 1964
between the USA and Canada?
Essay B (20 points) Countries X and Y have two factors of production, capital and labor,
with which they produce two goods, M and A. Technology is the same in the two
countries. M is capital-intensive; X is labor-abundant. Analyze the effects on the terms of
trade and on the welfare of the two countries of an increase in X’s capital stock. Explain
your answer in detail, including statements on how the theorems from Chapter 5 were
used as part of your answer. Moreover, explain a possible relationship between your
answer and the China 2025 plan discussed during the online lecture.
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