Question

Due to a trade blockade, only domestically produced rice is consumed in Corea whose supply and demand curves are as follows, respectively:

QS=P

QD=150-0.5P

Learning that the equilibrium rice price in the international market is set at Pw=$50, Corean consumers began requesting trade open to the government. The government will consult policy implementation. Answer the following parts. (15 points total)

1. Compute the equilibrium price (P*) and quantity (Q*) of rice under autarky (without trade). (2 points)

2. Compute the consumer (CS), producer (PS), and total surpluses (TS) in the domestic rice market before trade opening. (2 points)

3. Determine whether Sunny becomes an importing or exporting country after opening the domestic rice market to international trade, and compute the new equilibrium price (P’) and quantities of domestic demand (QD’) and supply (Qs’) of rice after opening the domestic rice market to international trade. (3 points)

4. Compute the consumer (CS’), producer (PS’), and total surpluses (TS’) in the domestic rice market after trade opening. (3 points)

5. The government is considering tariffs on rice to subsidize domestic farmers. With tariffs at $10 per unit, estimate new consumer (CS’’), producer (PS’’), total tariff revenues (TR) and total surpluses (TS’’)(3 points). Also derive the dead-weight loss due to tariffs. (2 points)

Answer 1

When QD = 0, P = 150/0.5 = 300 (vertical intercept of demand curve)

When QS = 0, P = 0 (vertical intercept of supply curve)

(I) In autarky, QD = QS

150 - 0.5P = P

1.5P = 150

P = 100

Q = 100

CS = (1/2) x (300 - 100) x 100 = 50 x 200 = 10,000

PS = (1/2) x (100 - 0) x 100 = 50 x 100 = 5,000

TS = CS + PS = 10,000 + 5,000 = 15,000

(II) With free trade, Pw = 50 < DOmestic price, so the country will import.

QD = 150 - 0.5 x 50 = 150 - 25 = 125

QS = 50

Import = QD - QS = 125 - 50 = 75

CS = (1/2) x (300 - 50) x 125 = 62.5 x 250 = 15,625

PS = (1/2) x (50 - 0) x 50 = 25 x 50 = 1,250

TS = 15,625 + 1,250 = 16,875

(III) After tariff, Domestic price = 50 + 10 = 60. At this price,

QD = 150 - 0.5 x 60 = 150 - 30 = 120

QS = 60

Import = QD - QS = 120 - 60 = 60

CS = (1/2) x (300 - 60) x 120 = 60 x 240 = 14,400

PS = (1/2) x (60 - 0) x 60 = 30 x 60 = 1,800

Tariff revenue = Unit tariff x Import = 10 x 60 = 600

TS = CS + PS + Tariff revenue = 14,400 + 1,800 + 600 = 16,800

Deadweight loss = Change in TS between parts (II) and (III) = 16,875 - 16,800 = 75