Reference no: EM13868668

Suppose that ?xed costs for a ?rm in the automobile industry (start-up costs of facto- ries, capital equipment, and so on) are $5 billion and that variable costs are equal to $17,000 per ?nished automobile. Because more ?rms increase competition in the market, the market price falls as more ?rms enter an automobile market, or speci?- cally, P = 17,000 + (150/n), where n represents the number of ?rms in a market. Assume that the initial size of the U.S. and the European automobile markets are 300 million and 533 million people, respectively.

a. Calculate the equilibrium number of ?rms in the U.S. and European automobile markets without trade.

b. What is the equilibrium price of automobiles in the United States and Europe if the automobile industry is closed to foreign trade?

c. Now suppose that the United States decides on free trade in automobiles with Europe. The trade agreement with the Europeans adds 533 million consumers to the automobile market, in addition to the 300 million in the United States. How many automobile ?rms will there be in the United States and Europe combined? What will be the new equilibrium price of automobiles?

d. Why are prices in the United States different in (c) and (b)? Are consumers better off with free trade? In what ways?