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International trade - Essay Example

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Name Date Institution of affiliation (a) Outline the basic framework of the Melitz model (see Sections 2, 3 and 5 of the paper). In particular, what key assumptions does the author make? In what sense can his model be described as one of monopolistic competition?…
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International trade

Download file to see previous pages... At the same time, least productive firms will be forced out and only produce for domestic market, this in turn will also lead to the exit of the least productive firms (Melitz, 2003). The Melitz model uses heterogeneous firms to perform its analysis under the general states of equilibrium. This concept explains how the exit of least productive firms leads to allocation of huge market shares to the well performing firms thus resulting into increase in productivity level. This indicates how certain firms are exposed to many opportunities by exit of the other non-performing ones. This paper also adapts the model for monopolistically competitive firms, that is, only highly competitive firms are given consideration under general equilibrium conditions. In addition, the concept suggests that uncertainty in production is a very important aspect and can help a great deal when trying to explain the behavior of firms. Uncertainty creates a business environment in which the players cannot predict the outcome of their competition and each firm therefore competes at its best. Also under this theory, there is an assumption that only the most productive firms that earn positive results remain in the competition. This analysis further puts focus on long run effects of this type of trade on performance and behavior of firms under different levels of productivity. Another very important aspect that this study emphasizes on is the introduction of dynamic future oriented market entry decisions by firms that are facing sunk costs of market entry. The study has focused on the importance of such market cost of such market entries and their effects on the firms’ competition. Description of the model The Melitz model focuses on three aspects to analyze its studies. These include demand, production, and aggregation. These aspects are relative and are majorly the key determinants in decision-makings. Demand Demand relates to consumer preferences. The preferences relating to the representative of the consumer can be got by CES utility function all over a range of goods that is represented by the company. The function below can be used in this analysis (w)q dw]1/p ? represent the value of the mass of the goods available. The available goods are considered a substitute which implies that P is less than 1, but greater than 0. 0 < p < 1. But the elasticity of substitution that exists between two commodities of -0 = 1(1 - p) > 1 Consumer behavior in regards to demand can be analyzed by considering a set of products that the consumer takes against the aggregate price of the commodities. The presence of simultaneous entry and exit during the state of steady equilibrium can be attributed to the sunken market entry cost. It also explains the survival probabilities of exporting firms in the market (Johnson, 2010). These aggregates can be applied in deriving optimal consumption and decisions regarding expenditure of various individuals. Production The industry has many firms, and each of these firms chooses to produce variety of products w. the production process is viewed to require only one important factor, that is labor. The factor of production labor L is in-elastically available at its total level. The technological level of these firms is represented by cost functions hat show constant marginal cost that is characterized by fixed overhead cost. Labor used can therefore be represented using linear function for output q i.e 1= f + q/q. An assumption that all firms share similar fixed cost f ...Download file to see next pagesRead More
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