Consider the standard version of the Melitz (2003) model that we studied in class.

a) Assume that due to a breakdown of international agreements, there is a multilateral increase in the variable trade cost, due to higher tariffs and non-tariff barriers. Show and discuss the effects of this episode of trade ‘disintegration’ on firms’ survival on the domestic and export market. Use equations and figures to construct your argument.

b) What is the impact of the increase in the variable trade cost discussed above on the economy’s real income (GDP)? Explain the different channels through which welfare (real income) is affected. Who wins and who loses from this episode of trade disintegration? Explain. Now assume that firms can choose to reach the foreign country via export or MNA, as we saw in class.

c) Abstracting from the general equilibrium effect on the aggregate demand shifter, that is keeping B constant, derive and discuss the effects of the increase in variable trade cost discussed above on firms’ choice between export and MNA. Derive and discuss the effect of an increase in the plant-level fixed cost fD on firms’ choice between export and MNA. Use equations and figures to construct your argument.

d) Allowing for the general equilibrium effect on the aggregate demand shifter, derive and discuss the effects of the increase in variable trade cost on firms survival on the domestic market, and on