Question

Suppose the aggregate demand for honey in a small country is given by Q^D = 100 − P and the aggregate supply is Q^S = P. The international price of honey is P^I = 60, and the world market is willing to buy or sell any amount at that price. Let all quantities be given in gallons and all prices in dollars per gallon. Suppose the country initially starts out with closed borders, and cannot import or export at all.

Suppose now the country enters into an international free trade deal. The deal eliminates all subsidies and price supports, and the country opens up to import and export from the world market.

(j) What is the equilibrium domestic price, production, and consumption in the honey market with free trade? Depict it graphically. Will the country be an importer or exporter of honey?

(k) Which groups are better off with free trade relative to autarky (with no subsidies/price restrictions)? Which are worse off?

(l) Does total surplus increase or decrease relative to the competitive equilibrium with no trade. Can you find a set of transfers that would make everybody at least as well off as in the no-trade equilibrium? Now suppose the government wants to provide some relief to domestic consumers, so it imposes an export tariff of $τ per gallon on honey imports.

(m) What is the new equilibrium in the honey market in terms of τ? Depict it graphically for τ < 10.

(n) What is producer surplus, consumer surplus, government transfers, and social welfare after the tariff?

(o) Suppose the government decides to give all its tariff revenue to consumers to compensate for the loss from trade. Is there any level of tariff that would make consumers as well of as in autarky without completely shutting down trade?

Answer 1