Question

5 7 9 15 17 11 13 10 12 14 19 21 20 (Thous.) 6 8 16 18

The graph above represents the market for T-shirts in Country X, a small country. Assume that there is free trade with the rest of the world (and no transportation costs) and that the world price of a T-shirt is $5.

Instead of using an import quota or tariff to protect the domestic T-shirt industry, Country X’s government gets the ROW’s government to agree to a voluntary export restraint (VER) that restricts exports to 6,000 T-shirts. The ROW’s government auctions off the export licenses to the highest bidder.

g. What is the highest price a T-shirt exporter in the ROW would be willing to pay for an export license (per T-shirt) auctioned off under the VER?

h. Use your answer in part (h) to compute the total revenue the ROW’s government gets from the sale of the export licenses for the 6,000 T-shirts.

Answer 1

Under free trade the price of T-shirt is $5. The domestic quantity demanded is 17000 and quantity supplied by the domestic producers is 5000. Thus the net import is equal to 12000(17000-5000). Under the voluntary export restrain the rest of the world agree to export a quantity only at 6000. When the quantity of import is restricted to 6000, the domestic price increase to $9 per T-shirt and the domestic supply increase to 7000 and domestic demand decrease to 13000. Now the import is equal to 6000(13000-7000).

g) The exporters willing to pay a highest maximum price equal to $9. They will pay only to the extent of price increase in the domestic market. After the quantity limit at 6000 the increase in price only at $9. So the exporters are willing to bid up the price under auction only to $9.

h) The total revenue that the rest of the world gets from auctioning the export license is equal to the increase in price after VER – free trade price × quantity of export. The revenue from the auction of export license to the government of exporting country (ROW)= $24000(4×6000).