Question

Country A is the world's largest consumer of Wine. Assume therefore, that the demand of country A for Wine is representative of the world demand. Production of wine takes place both by domestic and foreign suppliers. All prices are dollar denominated. A unit of wine is defined as a liter of Wine. Country A's demand for Wine is given by QD = 1200-200P Country A's supply of Wine is given by QS = 100P Foreign supply of Wine is given by QF S = 300P

(a) Calculate the equilibrium values of World price and quantity under free trade

(b) At this world price, what is Country A's consumption of Wine, production of Wine and the quantity of imports?

(c) Imagine that Country A imposes an import tariff of $2 per unit. What is the new equilibrium world price?

(d) What are Country A's consumption, production and level of imports post tariff?

(e) What price per unit do foreign firms receive, post-tariff? What price per unit do domestic firms receive, post-tariff? What is the tariff revenue earned by the government of Country A?

Answer 1

Solution:

a) QD= 1200-200P

QS= 100P and QFS = 300P

Under free trade total supply = QS + QFS = 100P + 300P = 400P

At equilibrium

QD = QS

1200- 200P = 400P

600P = 1200

P= 2

Quantity = 1200 – 200P = 1200 – 400 =800

b) At world price = 2 the country’s A consumption of wine = 1200 – 200P = 1200 – 400 =800

Production of wine = 100P = 100 x 2 = 200

Quantity of imports = 300P = 300 x 2 = 600

c) with the new tariff the foreign supply will be equal to 300(P-2)

Total supply = 100P + 300(P-2) = 100P + 300P – 600 = 400P - 600

At equilibrium,

1200- 200P = 400P - 600

600P = 1800

P= 3

d) At world price = 3 the country’s A consumption of wine = 1200 – 200P = 1200 – 600 =600

Production of wine = 100P = 100 x 3 = 300

Quantity of imports = 300(P-2) = 300P – 600 = 900- 600 = 300

e) After tariff the domestic firms will receive price equal to 3 and foreign price will be equal to Price - tariff = 3- 2 = 1. Government will receive revenue equals to tariff x quantity of imports = 2 x 300 = $600