Question

Assume the market for plastic kitchenware in your country has the demand curve P = 2000 – 0.01Q, and the domestic supply curve P = 500 + 0.02Q. For simplicity, we ignore the exchange rate and currency difference here.

1. Quantify the domestic market equilibrium without trade.

1.1.Calculate the Quantity and Price where the Demand and Supply functions intersect.

1.2. Calculate the consumer surplus, producer surplus, and national welfare without trade.

2. Suppose that free trade is allowed and that the price your country drops to the world price Pw = 1000.

2.1. Solve for the domestic demand, domestic supply, import, and the market share of domestic producer as well as the foreign producer (import).

2.2. Calculate the consumer surplus, producer surplus, and national welfare with free trade. How does that compare to National Welfare without trading as you calculated it above?

Answer 1

1.1) Set D=S

2000-0.01Q = 500+0.02Q

2000-500 = 0.02Q+0.01Q

1500 = 0.03Q

Q = 1500/0.03 = 50000

P = 2000-0.01*50000 = 1500

11.2)

P	QD	QS
2000	0	75000
1750	25000	62500
1500	50000	50000
1250	75000	37500
1000	100000	25000
750	125000	12500
500	150000	0

CS = 0.5*50000*(2000-1500) = 12500000

PS = 0.5*50000*(1500-500) = 25000000

TS = CS+PS = 37500000

2) With the world price, the price will decrease to 1000

Domestic demand = 100000

Dmestic supply = 25000

Imports = D-S = 100000-25000 = 75000

Market share of domestic producer = 25% and foreign producer = 75%

2.2) CS = 0.5*100000*(2000-1000) = 50000000

PS = 0.5*25000*(1000-500) = 6250000

National welfare = CS+PS = 56250000

So, National welfare increases from part 1 after trade by 56250000-37500000 = 18750000