Question

15) Scenario 1 Assume India is a small country. India’s demand and supply curves for licorice are:

D = 400 – 10P

S = 50 + 5P

India imports licorice at the price of $10 per bag.

15) Refer to Scenario 1. Determine the free trade quantity demanded and supplied. Then calculate and graph the following effects of an import quota that limits imports to 75 bags of licorice. a. Calculate the consumption and production effects from the import quota.

Answer 1

15. For a small nation, the demand or supply would not effect the world price, which is stated to be of $10. The domestic equilibrium would be where or or or dollars. Since it is greater than the world price of $10, the nation would import.

The import is basically the excess demand at the world price. The demand at the world price is units, while the domestic supply at the world price is units. The excess demand here is or units.

The free trade quantity demanded is 300 units (bags of licorice), quantity supplied domestically is 100 units, while the nation imports the rest 200 units, for the equilibrium price of $10.

(a) The import quota is of 75 units. Hence, the excess demand must be 75 units, ie or or or or dollars. This is still less than the domestic equilibrium price, and this means the nation still imports. At this price, the quantity demanded is units, and quantity supplied domestically is units. The rest of 75 units is imported, meeting the quota.

The graph is as below.

The red line represents demand, the blue line represents supply, the green line represents world price (world supply in this case since nation is importing) and the dotted green line represents world price after imposing quota.

The CS before imposing quota was area of triangle ACD, ie or or dollars. The PS before imposing the quota was area of region OHGC, which is difference between area of OKGC and area of HKG, ie or (since KG=OC) or (since HK=OK-OH, and OK=CG while OH=50 because supply is 50 units at P=0) or dollars.

The CS after imposing quota is area of triangle ABE, ie or or dollars. The PS after imposing quota is area of region OBFH, which is the difference between area of OBFL and a rea of FHL, ie or or or or dollars.

As can be seen, after the quota is imposed, the consumption decreased, along with the consumer surplus while the domestic production increased, along with the producer surplus.