Question

1. Assume that domestic demand function for oil is Q=200-P and the domestic supply function is Q=-20+P.

1. Calculate the perfectly competitive equilibrium quantity and price.
2. Calculate the consumer surpluss and the producer surpluss at perfect competition.
3. The country opens up for trade and the world price for oil is only $50. How much oil will be imported?
4. Calculate the consumer and producer surpluss and deadweight loss/gain (compared to no trade) under free trade.
5. Assume that the government imposes $10 per unit tariff on imported oil. How much oil will be imported?
6. Calculate the consumer and producer surpluss and deadweight loss/gain (compared to free trade) under tariff policy.

Answer 1

a. Equilibrium quantity and price is where demand = supply

200 - P = -20 +P So, P = 110; Q = 90

b. Consumer surplus = ½*(highest willingness to pay - Price) * quantity

= ½*(200 - 110) * 90 =½*90*90 = 4050

Producer surplus = ½*(price - lowest reservation price ) * quantity  

= ½*(110-20) * 90 = ½*90*90 = $4050

c. When oil price = $50:

Domestic production = -20+50 = 30 units
Domestic demand = 200 - 50 = 150 units
The difference of 120 units will be imported - that is, 150 - 30 = 120 units.

d. Consumer surplus = ½*(200-50)*150 = $11,250
Producer surplus = ½*(50 - 20) * 30 = $450
Deadweight gain = $3600 (CS + PS before free trade = 8100; After trade = $11,700: Difference = 3600)

e. When tariff is imposed:

Domestic supply = -20+60 = 40 units
Domestic demand = 200 - 60 = 140 units
The difference of 100 units will be imprted (140 - 40 = 100)

f. Consumer surplus = ½*(200-60)*140 = $9,800
Producer surplus = ½*(-20+60)*40 = $800
Deadweight loss = 2(½*10*10) = 100
Tariff revenue = 10 * 100 = $1,000