Question

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The demand for car in a country is given by D=12 000-200P, where P is the price of a car. Supply domestic car production is S=7000+50P.

a) Assuming economy is closed; find the equilibrium price and production of cars.

b) The economy opens to trade. The world price of cars is 18 units. Find the domestic quantities demanded and supplied, and the quantity of imports or exports. Who will favour the opening of the car market to trade, and who will oppose it?

c) The government imposes a tariff of one unit per car. Find the effects on domestic quantitative demanded and supplied, and on the quantity of import or export. Who will favour the imposition of the tariff and who will oppose it?

Answer 1

a)D = 12000 - 200P

S = 7000 + 50P

In equilibrium D =S

Hence 12000 - 200P = 7000 + 50 P

12000 - 7000 = 50P + 200P

5000 = 250P

P = 20

Substituting P = 20 in the demand equation (alternatively you can also substitute in the supply equation) we get

D = 12000 - 200(20) = 12000 - 4000 = 8000

Therefore equilibrium quantity demanded and supplied is 8000 cars and equilibrium price is 20

b) When the country opens to trade and the world price is P= 18,

Domestic demand and supply is obtained by substituting P= 18 in the domestic demand and supply equation respectively.

D = 12000 - 200(18) = 12000 - 3600 = 8400

S = 7000 + 50(18) = 7000 + 900 = 7900

At world price P= 18, D = 8400 but S = 7900. Demand is more than supply by 500 units. Therefore 500 cars will be imported.

An open economy is favoured by the buyers and opposed by the sellers as price falls to 18 units when the economy opens to trade.

C) a tariff of 1 unit per unit of car is imposed.

Therefore import price = world price + tariff = 18 + 1= 19

At P= 19

Domestic Demand (D) = 12000 - 200(19) = 12000 - 3800= 8200

Domestic Supply (S) = 7000 + 50(19) = 7000 + 950 = 7950

After tariff, demand is 8200 cars and supply is 7950 cars. Therefore after tariff only 250 cars will be imported. It can be seen that imports fall on imposition of tariff.

Since price increases after tariff, buyers will oppose the imposition of tariff and sellers will favour it.