Question

consider a small open economy. Suppose the market for corn in banana republic is competitive. The domestic market demand function for corn is Qd= 10-0.5P and trhe domestic market supplu function is Qs= P-2, both measured and billions of bushel per year. Also assume the import supply curve is infinitely elastic at a price of four dollars per bushel.

a) suppose the government imposes a tariff of two dollars per bushel. What will the new equilibrium price and quantity be? What is the domestic consumer surplus? Domestic producer surplus? Government tax revenue? Deadweight loss? Show all of these numerically and graphically.

Answer 1

Solution:- Domestic demand, Q = 10—0.5P , when P=0, Q=10 ( horizontal intercept of the demand curve) When, Q=0 then P= 20 ( vertical intercept of the demand curve)

Supply curve, Q= P—2 , when Q=0 , then P= 2 ( vertical intercept of the supply curve)

Now, at the equilibrium in auterky ( without trade) , domestic demand =domestic supply ; 10— 0.5P =P–2 or 1.5P = 12 , P = 12/1.5 = 8 ( equilibrium price)

Putting equilibrium price in the demand or supply function, Q = 8–2 = 6 ( equilibrium quantity).

Let's draw the required diagram to show the effect of trade with tariff.