Question

Andorra is a small country, incapable of affecting world prices. It imports peanuts at the world price of 10 cents per sack. Andorra’s demand for peanuts is given by: D = 400−10P. Andorra’s supply curve for peanuts is: S = −20 + 5P. Determine the equilibrium under free trade.

a) Calculate and show in a diagram the following effects of a quota that limits the import of peanuts to 60 sacks. The increase in the domestic price. The quota revenue. The loss due to production distortion. The loss due to consumption distortion. b) Could the Government of Andorra have achieved the same trade result using a tariff?

Answer 1

# Equilibrium under free trade-----

The Point where Qd=Qs

400-10p=-20+5p

Equilibrium price=28cents

Substituting the value of p in equations-----

Qd=Qs= Equilibrium Quantity=120 sacks of peanut

Making schedule+------

P. Qd. Qs

10. 300. 30

24. 160. 100

28. 120. 120

See graph-----

* The graph shows initial Equilibrium of domestic demand and supply curves.,where equlibrium price is 28 cents ,while Equilibrium Quantity is 120 sacks.

a)# under free trade, we find that , world price of peanut is 10 cents per sack ,so, total quantity of imports comes to 270 sacks(300-30), while the domestic Supply is 30 sacks .This way total supply of peanut sacks under free trade is 300 sacks.at the price of 10 cents per sack.

# Now Suppose ,the govt imposes import quota upto 60 sacks of peanut,( again see graph), now the domestic Supply will increase to meet demand ,which ultimately leads to rise in peanut price .upto 24 cents

- we find that ,when import limit is 60 sacks, domestic supply is 100 sacks while total demand is 160 sacks.This way, domestic production gets increased due to Imports quota.

- After Imports quota , domestic production = 100 sacks of peanuts ,while imports = 60 peanut sacks ,total demand =160 sacks

* Increase in domestic production = 70 sacks , from 30 sacks to 100

* Increase in domestic price =14 cents, from 10 to 24 cents

* Quota revenue = 840 cents or 8•4. $

{60×(24-10)}

Distortion-----

* Loss due to production distortion= shaded area DLF=490 cents

{1/2×(24-10)(100-30)}

* Loss due to Consumption distortion = shaded area MNH=980 cents

{1/2(24-10)(300-160)}

b) The govt could have to impose tariff 14 cents per sack of peanut to get same result..

Thanks..