Question

The U.S. market for automobile is produced by Ford (domestic firmin the US) and Honda (foreign firm in Japan). Suppose that the world consists of only two countries: the U.S.and Japan.The demand curve for automobiles in either country is:

Q = 10,000-P, where Q is the number of cars sold and P is the market price of car.

Both Ford and Honda produce at a constant marginal cost of $4,000 per car, and the two firms compete with each other like Cournot duopolists.

1. Case 1: Suppose that free trade is allowed, compute the equilibrium. Illustrate this equilibrium by diagram with Ford’s sales in the U.S.market on the horizontal axis and Honda’s sales in the U.S.market on the vertical axis.

2. Case 2: Suppose that the U.S.government imposes import tariff of $1,000 per car. What is the new equilibrium? Illustrate your answer on the same diagram that you have drawn for part (a).

3. With the use of appropriate diagram, analyze the welfare effect under free trade and with the import tariff as described in part (b), regarding the US consumer surplus, two firms’ profits, and the U.S.government’s tariff revenue?What is the effect of this import tariff on the U.S.’s total welfare (i.e. total surplus)?

4. Case 3: Suppose the U.S. government provides a subsidy to the domestic automobile industry amounting to $1,000 per car. What is the new equilibrium? Illustrate your answer on the same diagram that you have drawn for part (a).

5. With the use of appropriate diagram, analyze the welfare effect under free trade and with the subsidy as described in part (d), regarding the US consumer surplus, two firms’ profits, and the U.S. government’s subsidy cost?What is the effect of this subsidy on the U.S.’s total welfare(i.e. total surplus)?

Answer 1

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