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Exercises Lecture 8: Trade Policies
Exercises Lecture 8: Trade Policies
S = 20 + 20P
Derive and graph Homes import demand schedule. What would the price of wheat
be in the absence of trade?
2. Now add Foreign, which has a demand curve
D = 80 20P
and a supply curve
S = 40 + 20P
Derive and graph Foreigns export supply curve and find the price of wheat that
would prevail in Foreign in the absence of trade
3. Now allow Foreign and Home to trade with each other, at zero transportation cost.
Find and graph the equilibrium under free trade. What is the world price? What is
the volume of trade?
4. Assume that Home imposes a specific tariff t = 0.5 on wheat imports.
(a) Determine and graph the effects of the tariff on the following:
(i) the price of wheat in each country;
(ii) the quantity of wheat supplied and demanded in each country;
(iii) the volume of trade.
(b) Determine the effect of the tariff on the welfare of each of the following groups:
(i) Home import-competing producers;
(ii) Home consumers;
(iii) the Home government.
(c) Show graphically and calculate the terms of trade gain, the efficiency loss, and
the total effect on welfare of the tariff.
S = 400 + 200P
Notice that this assumption implies that the Foreign price of wheat in the absence of trade
would have been the same as in the previous problem.
1. Recalculate the free trade equilibrium and the effects of a 0, 5 specific tariff by Home.
2. Relate the difference in results to the discussion of the small country case in the text.
Exercise 3
Consider Fig. 1 and answer to the following questions.
P
14
8
World price + tariff
6
3
World price
D
10
40
60
80
Figure 1
100
1. In the absence of Trade how many units of the good does this country produce and
consume?
2. In the absence of trade what is the countrys consumer plus producer surplus?
3. With free trade and no tariffs, what is the amount of the good imported?
4. With a specific tariff t = 3 per unit, what is the amount of the good imported?
5. What is the effect of the tariff on the welfare of producers, consumers and government?
S = 50 + 5P.
Determine the free trade equilibrium. Then calculate and graph the following effects of an
import quota that limits imports to 50 bags.
1. The increase in the domestic price.
2. The quota rents.
3. The consumption distortion loss.
4. The production distortion loss.
Solutions Exercise 1
1. Homes import demand schedule M D is given by:
M D = D S = 100 20P 20 20P = 80 40P
HOME
P
P
S
1,75
1,5
1,75
1,5
MD
D
20
40 50 55
65 70 80
100
20
40 50 55
65 70 80
The price of wheat be in the absence of trade is given by the intersection of the
curves D and S and it equal to P = 2.
Algebraically, it is obtained from D = S (or M D = 0), hence:
80 40P = 0
P =2
100
FOREIGN
P
XS
P
S
3
2
1
D
40
60
80 Q
40
80
As previously, the price of wheat be in the absence of trade is given by the intersection
of the curves D and S and it equal to P = 1.
Algebraically, it is obtained from D = S (or XS = 0), hence:
40 + 40P = 0
P = 1
120 = 80P
PW = 1, 5
To find the volume of trade, it suffices to substitute the world price PW into either
the M D or the XS, so as to obtain:
80 40 1, 5 = 20 = Volume of trade without tariff (free trade)
Graphically, it is represented in Fig. 4
WORLD EQUILIBRIUM
P
XS
2
1,75
1,5
1,25
1
MD
10
80
20
4. (a) When Home imposes a tariff t = 0.5 on wheat imports, only the M D modifies
(the XS remains unchanged), and becomes:
60 40P = 40 + 40P
PT = 1, 25
S = 20 + 20 1, 75 = 55
while, by substituting PT in D and S you obtain, for Foreign:
D = 80 20 1, 25 = 55
S = 40 + 20 1, 25 = 65
where it should be clear that the new volume of trade is equal to 10, as shown
by Fig. 4.
(b) To determine the effect of the tariff on the welfare of the different groups, refer
to Fig. 5.
b=d=
5 0.25
= 0, 625
2
c = e = 10 0.25 = 2, 5
The reduction in consumers surplus is equal to a + b + c + d, hence it is equal
to 16,875.
7
1,75
1,5
1,25
d
c
e
50 55 65 70
D
100 Q
Solutions Exercise 2
To recalculate the free trade equilibrium and the effects of a 0, 5 specific tariff by Home
you need to determine the new XS, given by:
XS = S D = 400 + 200P 800 + 200P = 400 + 400P
The free trade equilibrium is given by the intersection of the XS with the M D as
follows:
M D = XS :
PW = 1, 09
PT = 1, 045
9.1 0, 455
= 2, 07
2
c = 18, 2 0, 455 = 8, 28
9
Solutions Exercise 3
1. 60.
1,545
a
1,09
1,045
D
41,8 50,9 69,1
78,2
10
= 80 5 = 75
2
2
Finally, the revenue for the government is given by:
amount imported amount of the tariff = 40 3 = 120
Solutions Exercise 4
1. To determine the free trade equilibrium, you just have to substitute the price PW = 10
into the demand and supply functions as follows:
D = 400 10 10 = 300
S = 50 + 5 10 = 100.
Hence the M D is
M D = D S = 300 100 = 200
which defines total imports of Acirema.
11
With a quota which limits imports to 50 bags, the increase in the domestic price can
be identified by equating the demand to the domestic supply + the quota, that is:
D = S + quota :
P = 20
quota
23,3
20
a
10
D
50 100
150
200
300
Figure 7
100 10
= 500
2
12
50 10
= 250
2
13