Question

The demand and supply for plates in Artist Country have the following characteristics: each buyer will demand at most one plate, and each seller will supply at most one plate. The buyer will demand one plate if the market price is below or equal to his/her reservation price, and the seller will supply one plate if the market price is above or equal to his/her marginal cost. The following table shows the number of buyers at each reservation price and the number of sellers at each marginal cost:

Reservation price (maximum price willing to pay)	Number of buyers	Quantity demanded	Market price	Marginal cost (minimum price willing to receive)	Number of sellers	Quantity supplied
$8	20		$8	$8	30
$7	40		$7	$7	40
$6	20		$6	$6	50
$5	70		$5	$5	40
$4	40		$4	$4	30
$3	40		$3	$3	30
$2	60		$2	$2	30
$1	40		$1	$1	20

                                                                                                                                       

1. Fill in the blanks in the above table and provide brief explanation on how to derive: (i) Quantity demanded and (ii) Quantity supplied in the above table. Brief explanation on how to derive “Quantity demanded. Brief explanation on how to derive “Quantity supplied”.
2. (b) Based on the “Quantity demanded” and “Quantity supplied” derived in part(a), what are the equilibrium price and quantity of plates in this market?
3. Calculate the magnitudes of consumer surplus given the information in the table and the equilibrium derived in part (b). Provide brief explanation on your calculations.
4. Suppose the world price of plates is $4 and Artist Country opens up to free trade. What will be the quantity of plates imported to or exported from Artist Country? (1 mark)
5. Will the social surplus in Artist Country increase or decrease after its opening up to free trade? Who are the winners and losers for Artist Country after free trade? There is no need to include any calculations in your answers.
6. What should the government of Artist Country do if it attempts to protect the losers in part (e) (i.e. consumers or producers of plates that suffer from a reduction in economic surplus)? State two trade intervention policies other than tariff and quota and briefly explain how each of them can serve this purpose.

Answer 1

a) The table:

Reservation price	Number of buyers	Quantity demanded	Market price	Marginal cost	Number of sellers	Quantity supplied
$8	20	20	$8	$8	30	270
$7	40	60	$7	$7	40	240
$6	20	80	$6	$6	50	200
$5	70	150	$5	$5	40	150
$4	40	190	$4	$4	30	110
$3	40	230	$3	$3	30	80
$2	60	290	$2	$2	30	50
$1	40	330	$1	$1	20	20

b) Quantity demanded is the cumulative sum of the reservation price. For example, when the market price is $7, those with reservation price of $7 and $8 will form demand for the good. When market price is $1, all the buyers in column 2 will demand that good because their reservation price is equal or greater than $1.

Similarly, Quantity supplied will have cumulative sum of sellers in reverse. The last cell in the last column is same as the last cell in the penultimate column. Those 20 sellers have MC = $1. Othe sellers' MC is higher. So they won't supply at market price = $1. But in the first cell of the last column, all selles are willing to supply goods as their MC is equal to or less than $8.

c) Equilibrium quantity = 150; equilibrium price = $5.

reason: At price of $5, quantity demanded = quantity supplied = 150.

c) Consumer surplus = $225

reason: Highest reservation price = $8. Equilibrium price = $5. Equilibrium quantity = 150

Consumer surplus = ½*(highest reservation price - equilibrium price) * equilibrium quantity

= ½*(8-5)*150 = 225

d) When world price = $4, quantity demanded = 190 ; and quantity supplied = 110 (from the table)
Therefore there will be a shortage of 80 units (190 - 110 = 80)
So, 80 plates will be imported.

e) Social surplus will increase after the country opens up for world trade. Because now there will be 190 plates available in the market compared to 150 at domestic equilibrium. So, consumers will gain as they get more quantity at a lower price. Producers will lose as they get lower price. Only those with MC equal to or lower than $4 will supply. So producer surplus decreases.

f) Government can impose a binding price floor which will provide an incentive for producers to produce more due to increased price. Secondly, government can give subsidy to domestic producer so that their lost surplus can be made good.