Question

Malaysia is an exporter of natural rubber. Initially, the world price of natural rubber is RM5 per kilogram. It costs RM1 per kilogram (on average) to transport natural rubber from Malaysia to overseas, and Malaysian natural rubber exporters pay these transport costs. So Malaysian natural rubber producers only receive RM4 per kilogram after they pay for transport. (a) Using a diagram, illustrate the demand and supply in the Malaysian natural rubber market. What is the domestic price of natural rubber (per kg) in Malaysia? Show the areas of consumer surplus and producer surplus that is created in Malaysia from the production and sale of natural rubber. Be sure to label your diagram carefully. [4 marks] (Hint: Malaysian natural rubber producers do not have to pay for the transportation cost if they sell their products domestically) (b) Suppose the Malaysian government decides that it is unfair for natural rubber producers to pay for transporting natural rubber overseas. To help natural rubber producers, the government 3 decides to pay domestic natural rubber producers RM1 for every kilogram of natural rubber that they export. The government does not pay any money for natural rubber sold in Malaysia. On a new diagram, show the effect of this government policy. How does it affect the price of natural rubber in Malaysia? What are the effects on consumer surplus, producer surplus, and government revenue? Does the policy lead to a deadweight loss? If so, illustrate the loss and explain what it means. If not, explain why the policy does not lead to a deadweight loss. Be sure to fully explain your answer. [6 marks]

Answer 1

A).

Consider the following fig below.

So, here “D” be the demand and “S” be the supply curve of “rubber”. So, at the price “RM4” the country is producing “S1” amount of rubber and domestic consumer are consuming “D1” level of rubber, => the initial level of export is given by “S1D1”.So, here the “CS” is given by the area “A+B+C” and the “PS” is given by the area “F+G+H+I”.

B).

If the government decided to help the domestic producers by paying the transportation cost, => the domestic producer will try to export more to the world market and reduce supply in the domestic market, => in world market and the domestic market the price increases to “RM5”.

So, the “CS” is given by “A”, => “CS” decreases by the area “B+C”. Now, the “PS” is given by “B+C+D+E+F+G+H+I”, => “PS” increases by the area “B+C+D”. Now the total government spending is given by, “B+C+D+E”, => revenue is “-(B+C+D+E)”.

So, here the dead weight loss is given by the area “C+E”. Now, as the government is helping the producer, => producer increase its production, => more than efficient level of rubber is produced, => deadweight loss of “E”. Similarly is price increased to “RM5”, => the “CS” decreases, => additional dead weight loss of “C”. So, here the total “dead weight loss” is given by “C+E”.