Question

2. Suppose that the small country describe in Q1 moves from autarky to open its economy to international free trade and the world price for this particular good is $100.

Q^S = 2P - 20

Q^D = 600 - 3P

a) Solve for the new equilibrium. Specifically, what is the quantity bought by the domestic consumers and the quantity sold by the domestic producers? Is this country importing or exporting this good and how many units? Calculate the new consumer, producer and total surpluses and the gains from trade in this market due to free trade. (6 points)

b) If the government decides to impose a tariff of $10 per unit imported in this market, solve for the new equilibrium. Specifically, what is the new quantity bought by the domestic consumers and the quantity sold by the domestic producers? Is this country importing or exporting this good and how many units? Calculate the new consumer surplus, producer surplus, government revenue and the deadweight loss. (7 points)

Answer 1

Part(a)

The given world price is $100

Quantity supplied:- 2 x 100 - 20 = 180 units

Quantity demanded:- 600 - 3 x 100 = 300 units

Quantity sold by the domestic producers is 180 units and quantity bought by the domestic consumers is 300 units

The quantity bought by the domestic consumer is higher than the quantity sold by domestic producers.

So, the country is importing (300 - 180) 120 units of that good.

If it was closed economy, market would have cleared when QS =QD

=> 2P - 20 = 600 - 3P

=>5P = 620

=>P = $124

Quantity = 228 units

Consumer Surplus:- .5 x (200 - 100) x 300 = 15000

Producer Surplus:- .5 x (100 - 10) x 180 = 8100

Total Surplus:- 23100

Part(b)

A tariff of $10 is imposed. So, price for the good will be $110

Quantity supplied by the domestic suppliers:- 2 x 110 - 20 = 200 units

Quantity bought be domestic consumers:- 600 - 3 x 110 = 270 units

Therefore, the country is an importer of the good and now, it imports 70 units after the tariff was imposed.

Consumer Surplus:- .5 x (200 - 110) x 270 = 12150

Producer Surplus:- .5 x (110 - 10) x 200 = 10000

Tariff/Govt Revenue:- (270 - 200) x 10 = $700

Deadweight Loss = 23100 - (12150 + 10000 + 700) = 250