Question

1.Question1
Suppose there is an island which used to have no trac connection with the outside world.
After several years, airports are built up in the island and there are planes to do the
transportation, so it is possible for the island to have international trade now.
(1) Before the international trade, the price of vehicles in the local market of the island is
higher than the world price, should the island imports or exports vehicles in the international
trade?
(2) Draw the graph of the supply and demand curve of the island's vehicles market.
Mark the size change of the consumer surplus and producer surplus before and after the
international trade. After the international trade, how does the consumer surplus change?
How does the producer surplus change? How does the total surplus change?
(3) Suppose the local government decide to impose a tari on the vehicles imported
from the outside world, but the price of the vehicles from the outside world plus the tari
are lower than the local market price of vehicle before the free international trade. Draw the
graph of the supply and demand curve of the island's vehicles market with tari. Mark the
size change of the consumer surplus and producer surplus before and after the international
trade. After the international trade, how does the consumer surplus change? How does the
government revenue change? How does the producer surplus change? How does the total
surplus change? You can draw the graph based on (2).

Answer 1

1) As the price of vehicles in the local market of the island is higher than the world price, the locals of the island must import vehicles in the international trade.

2)

In the above figure , demand and supply curves are drawn for the island's vehicle market. As the world price Pw is below the domestic price of the island Pd, the island will import X₁X₂ amount of vehicles with international trade.

Before trade, consumer surplus was denoted by area a and producer surplus was denoted by area b+d. Now, with international trade, consumer surplus increases to area a+b+c whereas, producer surplus is denoted by the area d only. Here, net rise in total surplus is equal to area c.

3)

In the figure above, when tariff is imposed on imports , net import falls to X₃X₄. As a result, consumer area falls by the area q+r+s+t (loss in consumer surplus). New consumer surplus is denoted by area a+b+c. Producer's surplus increases by area q. Thus, new producer's surplus is denoted by area q+d. Also, government gains in the form of revenue is denoted by the area s. However, area r and t is the dead weight loss or loss in efficiency due to imposition of tariff.