Question

1. The US has imposed protectionist policies for a variety of products, including steel. Suppose that US demand for steel is given by P = 12 – (1/12)*Q and US supply is given by P = (1/6)*Q. Suppose that RoW (rest-of-world) demand for steel is given by P = 12 – (1/12)*Q and RoW supply of steel is given by P = (1/18)*Q

   1. Find equilibrium quantity, price, consumer surplus, and producer surplus in the US if the US does not allow any trade.

   2. Find equilibrium quantity, price, consumer surplus, and producer surplus in the US if the US allows trade with RoW. How much does total surplus increase because of trade? (Hint: You need to solve for aggregate demand and aggregate supply. This will first require transforming the country-specific supply and demand functions into the form where Q is on one side of the equation and everything else is on the other side.)

   3. Based on your answer in (b), who in the US is more likely to support the transition to free trade – consumers or producers?

Answer 1

Given US Demand curve = P = 12-1/12Q

US supply curve = P = 1/6Q

ROW Demand Curve = P = 12-1/12Q

ROW Supply Curve = P = 1/18Q

Therefore, US equilibrium will be at the point where supply = demand

12-1/12Q = 1/6Q

12 = 1/6Q + 1/12Q

12 = 3Q/12

Q = 48

Therefore, P=8

Similarly, ROW equilibrium will be at a point where demand = supply

12-1/12Q = 1/18Q

12 = 1/18Q + 1/12Q

Q = 86.4

and therefore, P = 4.8

Therefore, surplus before free trade for US -

Consumer surplus = 1/2*4*48

CS = 96

Producer surplus = 1/2*8*48

PS = 192

Total surplus = CS + PS

Total Surplus = 288

Surplus after trade when the world prices would lower the prices for the US market also-

Consumer surplus = 1/2*7.2*86.4

CS = 311.04

Producer surplus = 1/2*4.8*28.8

PS = 69.12

Total Surplus = CS + PS

Total Surplus = 311.04+69.12

TS = 380.16

Therefore, the total surplus has increased when free trade was allowed but the producer's surplus has fallen, the consumer surplus has increased therefore, the consumer's are better off.