Question

consider a closed economy. suppose the market for corn in banana republic is competitive. the domestic market demand function for corn is Qd=18-P and the domestic market supply function is Qs=P-2, both measured in billions of bushels per year. in order to help the corn industry, the government initiated a price support program by purchasing 2 billion bushels corn in the market a)Draw a graph to show the market equilibrium price and quantity. Identify the area of dead weight loss on the graph. b) Calculate the new market equilibrium price and quantity Now consider a small open economy. The domestic supply and demand functions are the same as before. Also assume the import supply curve is infinitely elastic at a price of 4$ per bushel. c) suppose the government imposes a tarif of 3$ per bushel. calculate the total willingness to pay of the domestic consumer, domestic producer surplus and deadweight loss d) Now suppose instead of using tarif alone, the government uses a policy combination by imposing a tariff of 2$ per bushel and an import quota of 6 billion bushels at the same time. e) calculate the domestic consumer surplus, domestic producer surplus and dead weight loss

Answer 1

a.

When the government decides to purchase 2 billion bushels of corn, then the price increases to $11 as seen in the figure below. The deadweight loss has been shown in the figure with area denoting 1, 2, and 3.

Deadweight loss = Area(1+2+3)

b.

When the government purchases 2 billion bushels then the difference between the supply and demand must be 2

p-2 - 18 + p = 2

2P = 22

p = 11

Therefore, equilibrium price = $11

Quantity demanded at $11 = 18 - 11 = 7 billion bushels

Quantity supplied at $11 = 11-2 = 9 billion bushels

c.

World price = $4, as shown in the figure below.

As a tariff of $3 per unit is imposed, then the price becomes $4+$3 = $7.

Consumer's total willingness to pay = area below the demand line and above the price line = area(1+2) from the figure = 1/2 * (18-7) *11 = $60.5 billion

Producer surplus = area below the price line and above the supply line = area(3+6) in figure = 1/2 * (7-2) *5 = $12.5 billion

Deadweight loss = area(4+5) in figure above = 1/2 * (7-4) (5-2) + 1/2 * (7-4) (14-11) = $9 billion

d.

If the government imposes a tariff of $2, then the price becomes $6. At $6, imports should be = 12 - 4 = 8 billion bushels.

But At the same time, the government also imposes an import quota of 6 billion bushels. This means that imports cannot be more than 6 billion bushels. This can happen only when the price = $7. Therefore, new price = $7

So, d part will be same as c part

e.

As it is similar to c part for e part the graph is same, so

Domestic Consumer surplus = 1/2 * (18-7) *11 = $60.5 billion

Domestic Producer surplus = 1/2 * (7-2) *5 = $12.5 billion

Dead weight loss = 1/2 * (7-4) (5-2) + 1/2 * (7-4) (14-11) = $9 billion

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