Question

Supply and Demand for an imported good are given by QD = 30 – 4P and QS = 6 + 2P. Currently Canada allows free trade at a world price of $2.

a. Trade disputes lead the Canadian government to implement an import quota at Q = 6 units for this good. Provide a labelled diagram and calculate how introducing an import quota will affect consumer, producer and licensee surplus in the economy. Label the deadweight (efficiency) loss.

b. Clearly explain which elasticities are most important when trying to predict how much total surplus will decline when a quota is implemented.

Answer 1

Let me help on it step-by-step:

Equilibrium is where Demand = Supply
Demand function = QD = 30 – 4P
Supply function = QS = 6 + 2P

For equilibrium:
30 - 4P = 6 + 2P
24 = 6P
P = 4 = Equilibrium Market Price = 4

Putting value of 4 in demand function we get:
QD = 30 – (4 x 4)
QD = 14 = Equilibiurm market quantity = 14

Now see the diagram below:



Answer a.

Effect on consumer: At quota of 6 units only, there remain excess demand in the market. Actually 14 - 6 = demand for 8 units remains unfulfilled. In the graph it is represented by FE. It may lead to hike in prices as well.

Effect on producer: Producer has the capacity to supply 14 but can supply only 6 units after the quota is implemented. It means there will be a producer surplus in the market represented by GE in the graph. Producer will perhaps either look for other markets or is destined to bear losses or reduction in profitability.

Dead weight loss: Is represented by the area EFG in the graph.

Answer b.
"...which elasticities are most important...."
Let me list out a few as below:

• Price elasticity of substitute goods
• Elasticity of future expectation (such as expectation of government rolling back the quota policy)
• Elasticity of government policy (such as chances of resolving the trade dispute)
• Elasticity of competition (such as chances of same goods being provided by another friendly country)