Question

Lummerland is a small country that takes the world price of corn as given. Its domestic supply and demand for corn are given by the following demand and supply curves:

Demand: Q = 45 − 3P

Supply: Q = 3P − 9

a. Assume initially that Lummerland does not open to trade. What is the autarky equilibrium price and quantity?

b. Suppose Lummerland decides to engage in trade. Determine the quantity demanded, quantity supplied, and import given the world price of $6 per bushel of corn.

c. If the Lummerland government imposes a tariff of $1 (i.e., t = $1), what is the new domestic price? What is the amount imported?

d. Determine the effect of the tariff on the consumers, producers, and government in Lummerland, i.e. compute consumer surplus, producer surplus and government revenue before and after the introduction of the tariff.

e. Does the tariff change the price Lummerland pays on the world market? What is the net effect of the tariff on Lummerland’s welfare? Explain.

Answer 1

A) Autarky equilibrium,

45-3p=3p-9

54=6p

P=9

Q=3*9-9=18

B)Qd=45-3p=45-3*6=27

Qs=3p-9=3*6-9=9

Imports= Qd-Qs=27-9=18

C)New domestic price=world price + tariff=6+1=7$

New Qd=45-3*7=24

New Qs=3*7-9=12

New imports=24-12=12

D) Before tariff,

CS=1/2*27*(15-6)=121.5

PS=1/2*9*(6-3)=13.5

Goverment revenue=0

After tariff,

CS=1/2*24*(15-7)=96

PS=1/2*12*(7-3)=24

Goverment revenue=Tariff* imports=1*12=12

So due to tariff CONSUMERs surplus Decreases, producer surplus Increases and Goverment revenue Increases.

E) No, The price oaid by CONSUMERs is still 6$ after tariff ,only Increase in price goes to goverment.

Net welfare of the effect= change in consumer surplus+ change in producer surplus+ change in government revenue=(96-121.5)+(24-13.5)+(12-0)=-25.5+10.5+12=-3$

So welfare Decreases due to tariff .