ECON 355 – Problem Set
1. Suppose you are in a Krugman world with two identical countries and firms with identical costs.
Each firm has a fixed cost of 10 and a marginal cost of 0.25. Each firm faces the demand
curve
Q = S ×
1
n
− 0.02 × (P − P)
,
where S is market size, n is the number of firms, and P is the average price charged by
competitors.
a) If the market size in home is 500, SH = 500, find the number of firms, price, and markup
in autarky.
b) If the market size in foreign is also 500, SF = 500, what is the total number of firms in
our two country world in autarky.
c) Now suppose home and foreign move from autarky to free trade, so the market size each
firm faces becomes 1,000. Find the number of firms, price, and markup in free trade.
d) What are the sources of the gains from trade (GFT) in the Krugman model? How doe
these differ from the sources of the gains from trade (GFT) in the previous models we
studied?
2. Suppose the world price for a good is 10, PW = 10, and Home’s demand is given by QD =
100 − 2P. Initially, the marginal cost of producing in home is mc = 15 + Q. After producing
9 units, the marginal cost curve shifts to mc = 10 + Q. After producing another 8 units, the
marginal cost curve shifts down to mc = 8 + Q.
a) Find the net cost each year of an $8 per unit import tariff until the industry will produce
a strictly positive quantity without protection.
b) Calculate the producer surplus each year once the industry produces a strictly positive
quantity without protection.
c) If the country receives the producer surplus indefinitely, find the discount factor, β, that
makes the net present value (NPV) of protection zero.
3. This question involves using trade data from Harvard’s Center for Economic Development Atlas
of Economic Complexity.
Use the following settings:
• Product class: SITC4
• Detail level: 2
• Trade flow: gross
a) In 2019, Bangladesh exported 1.19 billion dollars of goods to Canada. Explain which
trade model(s) are consistent with the pattern of trade between Bangladesh and Canada.
Use trade data to support your answer.
b) It has been argued that South Korea’s prosperity is a result of its strong export-oriented
economy. Describe how South Korea’s export industry developed over time (1965 to
present). Focus on what goods it exported over this time and to which countries.