Consider a market for CDs in a country called Home that has only one producer, Music, Inc. Suppose that the demand curve is given by:
Q = 100 - P,
where Q is the number of CDs demanded in that country per month and P is the price per CD in that country. The marginal cost of producing a CD is $6.
(a) Work out the price, quantity, Music, lnc.'s profit, and consumer surplus under autarky.
(b) Now, suppose that although Music, Inc. is still unable to reach any export markets, a foreign producer is now able to sell in Home. Initially, the foreign producer sells 2 units in Home. Assuming that consumers view the foreign CDs as perfect substitutes for Music, Inc.'s CDs, and assuming that Music, Inc. takes as given that the foreign producer will sell 2 units in the Home market, compute Music, Inc.' s residual demand curve and equilibrium price, quantity, profit, and consumer surplus. Has Home's social welfare gone up or down? Interpret with a welfare diagram, explaining in terms of a competition effect and the rent transfer effect.
(c) Now, repeat part (b) under the assumption that the foreign producer will sell 90 units in the Home market. Do you get a different answer compared to part (b)? If so, why?