3.Assume that the world market for producing radios is monopolistically competit

Question

3.Assume that the world market for producing radios is monopolistically competitive. Suppose that the price of a typical radio is $25.

a.Why is this market likely to be characterized by two-way trade?

b.Suppose that Country A levies a tax of $5 on each radio produced within its borders. Will radios continue to be produced in Country A? If they are, what will happen to their price? If they are not, who will produce them?

c.If you concluded that radios will continue to be produced in Country A, explain what will happen to their price in the short run. Illustrate your answer graphically. d.What will happen to their price in the long run?

Explanation / Answer

(a)

Reason for a likely two-way trade is that the market is monopolistically competitive. Such a market structure is characterized by product differentiation. Even if all firms are selling radios, each radio is slightly differentiated from the others. Therefore, trade will not flow from one country only - it's likely to be two-way.

(b)

A unit tax of $5 increases the cost of production of radio in country A. It makes the radios made by country A more expensive, therefore uncompetitive in global market, since a monopolistic competitive firm has numerous sellers in the market, therefore buyers can quickly switch to other suppliers. So, with this tax, country A will eventually have to stop production of radios.

(c)

Not applicable as per answer in part (b).

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