Question

A. The Domestic Market, Now B. The Domestic Market, Future - If Domestic Production Now P ($) i 65 60 55 50 30 25 20 0 2 4 6 8 0 2 4 6 8 10 12 o 11 (Thous.) 1 3 5 7 10 12 11 9 1 3 5 7 9

5. Country Y, a small country, does not have a copy paper industry but does have vast forested areas that are not otherwise being utilized. A study by the country’s development agency finds that the production of copy paper could generate producer surplus (and hence increase Country Y’s welfare). However, high initial production costs currently prevent domestic firms from entering the market. According to the study, the market today and the market in the future look as depicted in the diagram above. Assume the world price of a box of copy paper is $35.

a. Redraw the supply and demand diagram for the domestic market now under free trade. Label the relevant prices and quantities, i.e., the domestic price, production, and consumption.

b. Suppose that the government decides to encourage the domestic paper industry by imposing a tariff of $10 per box of copy paper. Redraw the supply and demand diagram for the domestic market in this case. Label the relevant prices and quantities, i.e., the domestic price, production, and consumption.

c. What is the welfare effect of the policy described in part (b) in the current year for consumers, producers, the government, and Country Y as a whole? (Give $ values.)

d. Suppose alternatively that the government decides to encourage the domestic paper industry with a production subsidy of $10 per box of copy paper. Redraw the supply and demand diagram for the domestic market in this case. Label the relevant prices and quantities, i.e., the domestic price, production, and consumption.

e. What is the welfare effect of the policy described in part (d) in the current year? (Give a $ value.)

Answer 1

Answer a

A. The Domestic Market, Now P ($) 65 -L - -L - - 60 55 50 45 40 35 30 25 0 2 4 6 8 10 12 11 1 3 5 7 9

Domestic price will be equal to the World price ($35) because Market equilibrium price > World Price. Thus they will import the shrortage

At domestic price price $35. There will be no production as the P=35 function does not intersect the supply curve.

Consumption will be 10 units As the P=35 function intersects the demand curve at quantity 10

Answer 2

A. The Domestic Market, Now P ($) 65 -L - -L - - 60 55 50 45 40 35 30 25 0 2 4 6 8 10 12 11 1 3 5 7 9

The blue line ndicates the domestic price = World Price + Tariff = 35 + 10 = $ 45

At domestic price price $45 The production will be 2 units as P=45 intersects the supply curve at 2 units

The consumption will be 6 units as P=45 intersects the domestic curve at 2 units. The shortage 6 -2 = 4 units will be imported

Answer 3

A. The Domestic Market, Now -L - -L - - 2 4 6 8 10 12 11 1 3 5 7 9

(Blue region is consumers surplus)

Consumer Surplus = 1/2 x 10 (60-35) = $ 125

Producer's surplus = 0

Net welfare = 125 + 0 = $ 125

After Tariff

A. The Domestic Market, Now P ($) 65 -L - -L - - 6 . 55 50 45 40 35 30 25 0 2 4 6 8 10 12 11 1 3 5 7 9

(Area in yellow - producers surplus, Are