Question

Include correctly labeled diagrams, if useful or required, in explaining your answers. A correctly labeled diagram must have all axes and curves clearly labeled and must show directional changes. If the question prompts you to “Calculate,” you must show how you arrived at your final answer.

Assume that Grainland currently produces wheat and does not trade wheat in international markets.

(a) Draw a correctly labeled demand and supply graph for the domestic wheat market in Grainland. Label the equilibrium price, Pe, and the equilibrium quantity, Qe.

(b) Suppose the price of wheat in the world market is lower than the domestic price of wheat in Grainland. Assume now Grainland wants to trade wheat in the world market.

(i) On your graph from part (a), label the world market price of wheat as PW, and identify the domestic quantity demanded of wheat at PW, as Q3, and the domestic quantity supplied of wheat labeled as Q1.

(ii) Will Grainland export or import wheat? Explain.

(c) With international trade in wheat, who will benefit in Grainland: domestic producers, domestic consumers, neither or both? Explain.

(d) Suppose that the government of Grainland decides to provide a subsidy for wheat farmers to make the country more competitive and sell wheat at the world market price so that all wheat is produced domestically. Show the effect of the subsidy on your graph in part (a).

Answer 1

Assume that Grainland currently produces wheat and does not trade wheat in international markets.

a) The graph of domestic wheat market is shown as-

The initial equilibrium is shown at point e with equilibrium price Pe and quantity Qe.

b)

i) The world price for wheat is shown in the graph as Pw. And at Pw domestic demand and supply are Q3 and Q1 respectively.

ii) We can see that at world price Pw, domestic demand is greater than supply and hence there is shortage of wheat, so Grainland will import wheat by quantity Q1Q3.

c) With international trade in wheat, domestic consumers will benefit in Grainland, this is because now they have to pay less price and hence vonsumer surplus increases as shown in the shaded part in figure.

d) Suppose that the government of Grainland decides to provide a subsidy for wheat farmers to make the country more competitive and sell wheat at the world market price so that all wheat is produced domestically. This subsidy will increase the domestic supply of wheat and hence the supply curve will shift right and new equilibrium will be at e1. Now domestic demand is equal to domestic supply and hence no import is needed. Now Q3 quantity will be produced and consumed at Pw price.