Question

1. The domestic demand for good X in a small country is Dd=40-5P. The domestic supply for good X in that country is sd=20+5P.

1. Draw the domestic demand and supply curves for good X (Note: the price should appear on the vertical axis in the graph).
2. If the country allows no trade for good X, what are the equilibrium price, quantity produced and quantity consumed?
3. Imports of good X are available in the world market at Px=1. Draw the total supply curve. If the country allows free trade in good X, what are the equilibrium price, quantity produced domestically, quantity consumed domestically, and quantity imported?
4. If the country imposes a specific tariff of t=0.5 per unit of imported X, what are the equilibrium price, quantity produced domestically, quantity consumed domestically, and quantity imported?
5. Estimate the loss of domestic consumer surplus from imposition of the tariff.
6. Estimate the gain to domestic producers from imposition of the tariff.
7. Estimate the revenue gain to the domestic government from imposition of the tariff.
8. Estimate the net effect on the national welfare from imposition of the tariff.

Answer 1

a.) Given the domestic demand and the domestic supply curves, the following can help us establish the curves.

Dd = 40 - 5P

When P = 0, Dd = 40, When Dd = 0 , P = 8

Similarly, for supply Sd = 20 + 5P

When P = 0, Sd = 20, When Sd = 0 , P = -4

Hence, the coordinates are as follows -

	X intercept	Y intercept
Demand Curve	40	8
Supply Curve	20	-4

b.)

Equilibrium no trade quantity and price will be established at the point where the demand equals the supply -

Sd = Dd

20 + 5P = 40 - 5P

10P = 20

P = 2

Sd = Dd = 30

c.)

The supply curve will be a horizontal line at P = 1.

Equilibrium price = 1

Quantity produced domestically = 25

Quantity consumed domestically = 35

Quantity imported = 10

d.)

Per unit price will increase by 0.5, hence the new supply curve will be a horizontal line at P = 1.5

Equilibrium price = 1.5

Quantity produced domestically = 28

Quantity consumed domestically = 32

Quantity imported = 4

e.)

Loss of domestic sruplus is the area GKJB = area of GLB - area of KLJ = 1/2(35)(7) - 1/2(32)(6.5) = 18.5

f.)

Gain for domestic producers is GKHA = [1/2(25 + 28)] x 0.5 = 13.25

This is obtained by using the formula for area of the trapezium.

g.)

Revenue gain is quantity imported multiplied by tariff per unit = 4 x 0.5 = 2

h.)

The total deadweight loss is deadweight loss for consumers plus deadweight loss for producers =area of AHM + area of NJB = 1/2(3)(0.5) + 1/2(2)(0.5) = 1.25