Wine producers are located in two markets: Argentina and Chile. They engage in monopolistic competition and all rms have marginal cost equal to c = 1,fixed cost equal to F = 200, and a parameter b reacting sensitivity of quantities to prices equal to b = 0:2. Argentina has market size SA = 2560, and Chile has market size SC = 1440 (Recall that in this model we have Q = S[1/n – b(P – P)]).

(a) Derive what happens to variety, price, the markup and quantity as the two markets integrate. For which market are the absolute changes in prices and rm quantities larger?

(b) In the standard analysis we have ignored trade costs. Imagine instead that there is a per-unit trade cost t for selling in the other market, and that t = 3. Under these circumstances, is there trade or not? To solve for that,you have to check whether a Chilean firm would find it profitable to export to Argentinian market and whether an Argentinian firm would find it profitable to export to Chilean market.

(c) Now imagine that t falls to 1:5. Is there trade or not? If yes, are both countries exporting now? Without solving for equilibrium, argue how do exporters in a given market compare to domestic firm in terms of their prices,quantities sold in this market and markups?