Question

6. What is a tariff and what is a quota in international trade?

(a) In Tessland, suppose the domestic demand curve for sugar is given by: P = 16 - 0.05Q and the domestic supply curve is given by: P = 4 + 0.05Q:

i. In the absence of any trade, what is the equilibrium price and quantity of sugar? How much are the consumer surplus and domestic producer surplus?

ii. Suppose the equilibrium price of sugar in the world market is P = 6. How much are the new consumer surplus and new domestic producer surplus?

iii. Suppose Tessland is government imposes tariff $2 per unit (a ton) of sugar.

A. What will be the new effective price in the domestic market?

B. As a result, how much are the change in consumer surplus and change in domestic producer surplus compared to (ii)?

C. How is the loss in consumer surplus redistributed between domestic producer surplus, foreign producer surplus, government is revenue resulting from tariff and dead-weight loss to the society?

***PLEASE ONLY ANSWER FROM HERE (iv) AND BELOW. THANK YOU SO MUCH***

iv. Suppose, instead of imposing the tariff in (iii), Tessland is government imposes a quota restriction of 120 units of sugar.

A. What will be the new effective price in the domestic market?

B. As a result, how much are the change in consumer surplus and domestic producer surplus compared to (ii)?

C. How is the loss in consumer surplus redistributed between domestic producer surplus, foreign producer surplus, government is revenue resulting from quota and dead-weight loss to the society?

(b) Distinguish between a tariff and a quota. In what ways are they similar and in what ways are they different?

Answer 1

2) When P = $6, then quantity demanded can be found out by putting P = 6 in the demand equation

P = 16 – 0.05Q

6 = 16 – 0.05Q

0.05Q = 10

Q = 200

When P = $6, then quantity supplied can be found out by putting P = 6 in the supply equation

P = 4 + 0.05Q

6 = 4 + 0.05Q

Q = 40

Consumer surplus at world price = area below the demand line and above the price line = area highlighted in black in figure 2 = ½* (16-6) * 200 = $1000

Producer surplus at world price = area below the price line and above the supply line = area highlighted in blue in figure 2 = ½* (6-4) * 40 = $40

Figure 2

4) If the government imposes 120 units quota, then demand – supply = 120. This happens when price = $7.

At $7, demand: 7 = 16-0.05Q

Q= 180

At $7, supply: 7 = 4+ 0.05Q

Q = 60

So, import = 180-60 = 120 units

Figure 2

4.a) new effective price = $7

4.b) Consumer surplus = area highlighted in black in figure 2= ½ * (16-7)*180 = $810

Change in Consumer surplus = $810 - $1000 = -$190

Producer surplus = area highlighted in red in figure 2= ½ * (7-4)*60 = $90

Change in producer surplus = $90 - $40 = $50

4.c) Quota rent = area highlighted in green in figure 2 = $1*(180-60) = $120

Deadweight loss = area highlighted in blue in figure 2 = ½* (7-6)(60-40) + ½ * (7-6) (200-180) =$20

So, out of $190 decrease in consumer surplus, $120 is quota rent, $20 is deadweight loss and remaining (190-120-20 = $50) goes to producer surplus.

b) Putting 120 units quota in this example is the same as putting $1 tariff on sugar. The difference between quota and tariff is the use of quota rent. In tariff, the green area is government tariff revenue. But in case of  quota, the green area is quota rent. It can go to domestic producer (if quota is allocated in domestic producer), foreign producers (voluntary export restraint) or the government (if the rent is auctioned).