Question

Econ 178-001 International Trade Problem Set 1

All of the questions in this assignment refer to material found in Chapter 9 on tariffs and quotas.

1. Home is a small country with a demand curve for wheat described by QD = 1000 – 100P. Its supply curve is described by QS = 100P.

*please part e-h only*

a. Graph this market. What is the equilibrium price and quantity in the absence of trade?

b. Calculate the consumer and producer surplus at the no trade equilibrium.

c. Derive the equation for the import demand curve. Graph it on a separate graph for the world market.

d. Imagine that the world price of wheat is $2. How many units of wheat are imported at this price? Draw this on your graph in part (a) and your graph in part (c). Also calculate and mark the amount of wheat that is produced domestically and the amount that is consumed domestically.

e. Calculate consumer and producer surplus with trade. How much additional surplus was gained from trade?

f. Now imagine that the Home government places a $1 per unit tariff on wheat. Redraw the graphs you did in part (a) and part (c) of question 1. Calculate and label the values of domestic supply, domestic demand, and imports.

g. Calculate the consumer surplus, producer surplus, government revenue and deadweight loss that occurs because of the tariff. Mark each of these on your graphs in part (a).

h. The deadweight loss from the tariff is represented by two different triangles in your graph that represents the Home market. Describe what each triangle means intuitively (i.e. in the real world)

Answer 1

Answering Questions (e) to (h) as per instruction in the question:

e) With trade:

CS = ½*8*800 = 3200
PS = ½*2*200 = 200

A surplus of 900 was gained from trade.

Reason: Before trade, total surplus (CS + PS) was 2500. After trade, it is now at 3400. So an additional 900 (3400 - 2500) was gained because of trade.

f) With tariff of $1, price is now $3. Domestic supply = 300 units (Q = 100P = 100*3 = 300)
Domestic demand = 700 units ( Q = 1000 - 100P = 1000-100*3 = 700
The difference between domestic demand and supply , that is, 400 units (700 - 300) will be imported.

g) Consumer surplus = ½*7*700 = 2450 (area of the triangle below the demand curve and above price line of $3)
PS = ½*3*300 = 450 ( area of the triangle above the supply curve and below the price line of $3)
GR = 1*400 = 400 (tariff amount *quantity of import)
DWL = 2(½*1*100) = 100 (area of the triangle between GR and demand / supply curve).

h) Deadweight loss is represented in two triangles. The one on the right hand side is associated with demand curve. It represents loss of consumer surplus. As a result of increased price by the amount of the tariff, consumers represented on that part of the demand curve are unable or unwilling to buy goods. The triangle on the left hand side is associated with supply curve. It represents those producers who are producing at a higher opportunity cost now.