Reference no: EM133080448

Question: 

At Home country, the industry of canned tomato is a monopolistically competitive industry where all firms are identical, except for the fact that they produce slightly different varieties of canned tomato. When the firms in this industry increase production by one unit, their total cost increases by $12, irrespective of the total quantity of production. At zero production, the firms in the industry would incur a total cost of $3,000. 

1. Now assume that each firm in the industry has the same market share, so the quantity of tomato cans that each firm produces () is equal to the total sales in the market () divided by the number of participating firms ().

Total sales in the market () are equal to $30,000. Derive the firms' average cost to show that the average cost curve (CC) is given by:

Curve:  

1. The demand side of the canned tomato market is represented by the following  curve, which summarises price competition in the industry.

Curve:

Illustrate the curve and the curve on a graph with price and cost on the vertical axis, and the number of firms on the horizontal axis.  Solve for the market equilibrium at Home in autarky, that is, find the equilibrium number of producers and the equilibrium price of canned tomato. 

1. Suppose that Home is now able to trade with two other identical countries. Solve for the trading equilibrium in the industry and illustrate this change in trading equilibrium on a graph (this new graph is based on the graph you drew in point (b), with the addition of the change in equilibrium after trade).
2. Explain the effects of trade on the industry of tomato cans.
3. Now imagine a scenario where firms in the industry of canned tomato at Home also differ in terms of their productivity, that is, marginal costs are different across firms. Consider the following graph representing two of the firms participating in this market at Home in autarky.

Note that both firms face the same demand curve (D). The slope of D is given by:

Where is the size of the market and is a parameter that indicates the sensitivity of a firm's demand to changes in the firm's price. 

Assume that Home now opens to free trade under this new scenario. Use the graph above (you could redraw it by hand if you preferred) to show the effect of trade on this market. Briefly explain how trade may affect firms differently, depending on their level of productivity.