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(15 marks total) Use a model of internal economies of scale, but now allow for firms...

(15 marks total) Use a model of internal economies of scale, but now allow for firms to have different marginal costs (c ).

Explain why opening up to trade results in the lowest cost firms expanding and the highest cost firms shutting down. Draw one or more diagrams to help you explain your points. Is this consistent with empirical evidence on how firms react to trade openness? Assume that there are no trade costs for part a.      

Now assume that some trade cost (t) exists in order for a firm to export, per unit. How will increasing the trade cost t affect which types of firms export and which do not? From your answer, how would you conclude Canadian firms and consumers might be affected by a potential collapse of the North American Free Trade Agreement (NAFTA)? You may want to draw a diagram to help make your points in the first part of the question, although it is not absolutely necessary.       

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