Question

Suppose the world price of bicycles is below the domestic price in a small open economy.

d. (3) Define and give an example of consumption dead weight loss

e. (3) Define and give an example of production dead weight loss.

2. (4) Give two reason why a nation might have import product standards?

3. (4) What is mercantilism? Is trade a zero-sum game?

Answer 1

Ans-3d) Consumption dead weight loss refers to the loss of consumer surplus due to inefficient allocation of resources or market inefficiency. It is the gap between consumption value under free economy and consumption volume under an inefficient market.

Example -: Imposition of tax on the world price of bicycles would increase the price of bicycles and the consumer would now purchase less bicycles owing to higher prices. They experience a loss in consumer surplus due to taxes.

Ans-3e) Production dead weight loss refers to the cost borne by suppliers/producers due to market inefficiencies.

Example-: A price ceiling lower than the free market price decreases the producer surplus and creates inefficient market. As a result , some producers exit the market and leads to dead weight loss on production side.

Ans-4)A nation might have import product standards for following 2 reasons-:

• To decrease the imports and improve trade deficit . (The imports can be decreased under import standards by not allowing low quality foreign products to protect domestic economy)
• To save domestic infant industry. (The import standards would restrict the supply of imports and save the domestic industries from low cost and low quality competitors)

Ans-4)Mercantilism was an old economic system that flourished in the period between 16-18th century. It emphasizes on increasing exports and decreasing imports as in this way one would be able to maximise his/her wealth. Mercantilists advocated that the trade is a zero sum game and supported protection of the economy by import restriction.

In the view of Mercantilists, trade was a zero sum game but their idea was refuted by Adam Smith in his book 'Wealth of Nations' . He stated that a free and laissez faire economy instead of closed economy would benefit the both the players of trade. Thus, in his view trade was a positive sum game and not a zero sum game. With time, Adam Smith's idea of trade as a positive sum game has been accepted but the present times are leading us back to the era of protection and seeing free trade as a zero sum game.