Question

 1. Welfare effects of free trade in an exporting country

 Consider the Kenyan market for lemons.

 The following graph shows the domestic demand and domestic supply curves for lemons in Kenya. Suppose Kenya's government currently does not allow international trade in lemons.

 Use the black point (plus symbol) to indicate the equilibrium price of a ton of lemons and the equilibrium quantity of lemons in Kenya in the absence of international trade. Then, use the green triangle (triangle symbol) to shade the area representing consumer surplus in equilibrium. Finally, use the purple triangle (diamond symbol) to shade the area representing producer surplus in equilibrium.

Answer 1

Ans. The initial equilibrium before trade is shown at point E in Figure 1.1 below:

FIGURE 1.1:

Corresponding to point E, in the absence of international trade, the equilibrium price of lemons is $620/ton and equilibrium quantity sold is 225 tons of lemon in Kenya.

Consumer equilibrium is shown as the area of triangle shaded with green and producer surplus is shown as area of triangle shaded with purple.

Consumer surplus will be calculated as = (300×225)/2 = $33750.

While, Producer surplus will be calculated as = (300×225)/2 = $33750.

So, the total surplus in the absence of international trade = 33750+33750 = $67500.

Now, if the Kenya government enters into a free trade policy, with world price of lemons = $800/ton, the new consumer surplus and producer surplus are shown in Figure 1.2 below;

FIGURE 1.2:

Since Kenya has now entered into free international trade, the producers will sell at a price equal to the world price, i.e., $800/ton of lemons. So at this price, the total quantity sol by the producers will be 360 tons of lemons out of which, only 90 tons of lemon will be sold in domestic market and remaining 260 tons of lemon will be exported.

Therefore, as shown in figure 1.2, the consumer surplus has declined due to international trade, shown as the area of triangle shaded green while the producer surplus has increased due to international trade, shown as the area of triangle shaded with purple.

The after trade Consumer surplus= (120×90)/2 = $5400.

While the after trade Producer surplus = (480×360)/2 = $86400.

Thus the total surplus after trade = 5400+86400 = $91800

Hence, when Kenya allows free trade, the country's consumer surplus decreases by $28350 ($33750-$5400) and, country's producer surplus increases by $52650 ($86400-$33750).

So, the net effect of international trade on Kenya's total surplus is an increase by $24300 ($91800-$67500).