Question

Suppose that, in the market for strawberries, domestic demand is given by P= 40 – 0.5Q, and domestic supply is given by P = 0.5Q, where Q represents tonne of strawberry. Further, suppose that the world price of strawberry is $5 per tonne, and the government decides to place a $10 per tonne import tariff on strawberries.

A. On a graph, demonstrate the effect of the tariff on the equilibrium quantity of imports. (Clearly label the values both with and without the tariff.)

B. Show on the graph and calculate the tariff revenue and deadweight loss that results from the imposition of the tariff.

C. Explain why the tariff results in a reduction in total surplus in the market. (I.e., what are the reasons for the appearance of deadweight loss?) (detailed answer)

(You can draw the graph, take a picture and attach it here. Please do *not* take a picture of your hand-written answer, it is much easier for your marker to read typed text)

Answer 1

Demand: P = 40 - 0.5Q

Supply: P = 0.5Q

At equilibrium, demand = supply

40 - 0.5Q = 0.5Q

Q = 40

At Q = 40, P = 20

a) World price = $5, Demand at this price is 70 units while supply is 10 units which means there is imports of 70 - 10 = 60 units

Tariff on world price = $5 + $10 = $15. Demand at this price is 50 units while supplys is 30 units which means there is imports of 50 units - 30 units = 20 units

b) Tariff revenue is area of portion B + C in the above diagram whose sum is (15 - 5) * (50 - 30) = 200

Deadweight loss is area of portion A + D whose sum is (1/2) * (15 - 5) * (30 - 10) + (1/2) * (15 - 5) * (70 - 50) = 200

c) Rise in tariff cause deadweight to rise because price consumers pay rises which reduce their quantity demanded. Portion of Loss of consumer surplus is not gained by producers or government which result in deadweight loss.