KEY POINTS

1. The monopolistic competition model assumes differentiated products, many firms, and increasing returns to scale. Firms enter whenever there are profits to be earned, so profits are zero in the long-run equilibrium.
2. When trade opens between two countries, the demand curve faced by each firm becomes more elastic, as consumers have more choices and become more price sensitive. Firms then lower their prices in an attempt to capture consumers from their competitors and obtain profits. When all firms do so, however, some firms incur losses and are forced to leave the market.
3. Introducing international trade under monopolistic competition leads to additional gains from trade for two reasons: (i) lower prices as firms expand their output and lower their average costs and (ii) additional imported product varieties available to consumers. There are also short-run adjustment costs, such as unemployment, as some firms exit the market.
4. The assumption of differentiated goods helps us to understand why countries often import and export varieties of the same type of good. That outcome occurs with the model of monopolistic competition.
5. The gravity equation states that countries with higher GDP, or that are close, will trade more. In addition, research has shown that there is more trade within countries than between countries.