Question

3) Assume you are given the following equations for demand and supply: lo = 10 – 2P Qs = P-2 a) Calculate the (autarky) equilibrium price, quantity and welfare. b) Assume the world price is 2$. What is the welfare gain from trade? c) Assume a tariff of 1$ is imposed on the market. Graphically explain the changes in welfar for each actor under b) (consumers, producers, government, overall welfare).

Answer 1

World price+tariff World price D 1 2 4

a) Set QD=QS

10-2P=P-2

10+2 = P+2P

12 = 3P

P = 12/3 = 4

Q = 10-2*4 = 2

CS = 0.5*2*(5-4) = 1

PS = 0.5*2*(4-2) = 2

TS = 1+2 =3

b) When the world price is 2,

QD = 10-2*2 = 6

QS = 2-2 =0

CS = 0.5*6*(5-2) = 9

PS = 0

TS = 9

So, there is a welfare gain of 9-3 = 6

c) Under the tariff, the price increases to 3 where

QD = 10-2*3 = 4

QS = 3-2 =1

CS = 0.5*4*(5-3) = 4

PS = 0.5*1*(3-2) = 0.5

Tariff revenue = 1*3 = 3

TS = 4+0.5+3 = 7.5

Deadweight loss = 9-7.5 = 1.5