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Thi Final Cho Lòi Loz M
Thi Final Cho Lòi Loz M
Derive and graph Home’s import demand schedule. What would the price of wheat
be in the absence of trade?
D∗ = 80 − 20P
S ∗ = 40 + 20P
Derive and graph Foreign’s 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?
(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.
1
Exercise 2, from KOM
Suppose that Foreign had been a much larger country, with domestic demand and supply
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 S
3 World price
2 D
10 40 60 80 100 Q
Figure 1
2
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 country’s 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?
Determine the free trade equilibrium. Then calculate and graph the following effects of an
import quota that limits imports to 50 bags.
3
Solutions Exercise 1
1. Home’s import demand schedule M D is given by:
HOME
P P
S
5
2 2
1,75 1,75
1,5 1,5
1 1 MD
D
20 40 50 55 65 70 80 100 20 40 50 55 65 70 80 100
Q Q
Figure 2. Home’s Import Demand Curve
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
4
2. Foreign’s export supply curve XS is given by:
FOREIGN
P P XS
S
4
3
1
1
D
40 60 80 Q 40 80
Q
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
5
3. The equilibrium under free trade is given by M D = XS, that is:
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:
WORLD EQUILIBRIUM
XS
{
1,75
t 1,5
1,25
MD
10 20 80 Q
4. (a) When Home imposes a tariff t = 0.5 on wheat imports, only the M D modifies
(the XS remains unchanged), and becomes:
6
hence the new price, namely PT∗ , is given by:
PT = PT∗ + t = 1, 25 + 0, 5 = 1, 75
To determine the the quantity of wheat supplied and demanded in each country
as well as the new volume of trade, it suffices to substitute the correct price,
either PT or PT∗ in the demand and supply functions.
Hence, substituting PT in D and S you obtain, for Home:
D = 100 − 20 × 1, 75 = 65
S = 20 + 20 × 1, 75 = 55
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.
5 × 0.25
b=d= = 0, 625
2
c = e = 10 × 0.25 = 2, 5
7
P S
b
1,75 d
a c
1,5
e
1,25
D
50 55 65 70 100 Q
Figure 5. Welfare, efficiency loss and terms of trade gain.
8
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:
The free trade equilibrium is given by the intersection of the XS with the M D as
follows:
By following the same reasoning as the previous exercise, the volume of trade with no
tariff (P = 1, 09) is therefore equal to 36,4 (you just need to substitute the price into
either the M D or the XS), while the volume of trade with the tariff is equal to 18,2 (in
this case either you plug PT into the M D or PT∗ into the XS).
There are important differences also when it comes to analyze welfare, as Fig. 6 shows.
9.1 × 0, 455
b=d= = 2, 07
2
c = 18, 2 × 0, 455 = 8, 28
9
e = 18, 2 × 0, 045 = 0, 819
It is important to underline that - given the assumptions of the exercise - now the efficiency
loss, b + d = 4, 14 is much bigger in comparison to the terms of trade gain, equal to
e = 0, 819, as a consequence of the different variation of prices.
This small country example where the distortionary losses from the tariff overcome the
terms of trade gains should then make it clear that the smaller the economy, the larger
the losses from a tariff due to smaller terms of trade gains.
Solutions Exercise 3
1. 60.
P S
1,545
a c
b d
1,09
e
1,045
D
41,8 50,9 69,1 78,2 Q
Figure 6. Welfare, efficiency loss and terms of trade gain.
10
2. The consumers’ surplus is equal to
6 × 60
= 180
2
, which is also equal to producers’ surplus. Hence the total surplus (consumers +
producers) is equal to 360.
3. With free trade, you have to consider the world price PW = 3, thus the amount of
good imported is equal to 100 − 10 = 90
4. With a specific tariff t = 3 per unit the amount of good imported is equal to
80 − 40 = 40
40 × (6 − 2) 10 × (3 − 2)
− = 80 − 5 = 75
2 2
Finally, the revenue for the government is given by:
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
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:
P S
23,3
20
a b
10
D
50 100 150 200 300 Q
Figure 7
100 × 10
b= = 500
2
12
4. The production distortion loss is given by the area a, where
50 × 10
a= = 250
2
13