Question

The diagram below represents the market for boxes of copy paper in a small country. Assume that the world price of a box of copy paper is $40.

3 30 25 20 15 10 8 16 18 10 12 14 11 13 15 20 22 24 Q 19 21 23 (Thous.) 9 17

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

b. Draw a supply and demand diagram for the international market under free trade. Label the relevant prices and quantities, i.e., the P-axis intercepts, international price, and volume of trade.

Now suppose that the country offers a $10 export subsidy per box of copy paper (and imposes a $20 import tariff to prevent consumers from importing copy paper at the international price).

c. Redraw the supply and demand diagram for the domestic market with the export subsidy. Label the relevant prices and quantities, i.e., the domestic price, production, and consumption.

d. Draw a supply and demand diagram for the international market with the export subsidy. Label the relevant prices and quantities, i.e., the P-axis intercepts, international price, and volume of trade.

e. What is the change in consumer surplus resulting from the export subsidy? (Give a $ value.) What is the deadweight loss resulting from the export subsidy? (Give a $ value.)

Answer 1

The supply and demand diagram for the domestic market under free trade is shown in FIGURE 1.

FIGURE 1 WORLD PRICE 8 10 12 14 16 18 20 22 24 (Thousands)

As shown in the diagram, domestic market equilibrium is at E. The corresponding domestic price will be $20 and quantities, i.e., the production, and consumption will be 16 thousand.

b. The supply and demand diagram for the world market under free trade is shown in FIGURE 2.

FIGURE 2 8 10 12 14 16 18 20 22 24 THOUSANDS

As shown in the diagram, domestic market equilibrium is at E. The corresponding price will be $40 and quantities, i.e., production, and consumption will be 14 thousand.

c.The supply and demand diagram for the domestic market after the export subsidy of $10 is shown in FIGURE 3.

FIGURE 3 WORLD PRICE world price after export subsidy 8 10 12 14 16 18 20 22 24 (Thousands)

As shown in the diagram, domestic market equilibrium is at E. The corresponding domestic price will be $20 and quantities, i.e., the production, and consumption will be 16 thousand. It means domestic price and quantities, i.e., the production, and consumption will be the same.

d. The supply and demand diagram for the world market after the export subsidy is shown in FIGURE 4.

FIGURE 4 8 10 12 14 16 18 20 22 24 THOUSANDS

As shown in the diagram, the world market equilibrium is at E. The corresponding price will be $35 and quantities, i.e., production, and consumption will be 15 thousand. It means the export subsidy resulted in a reduction in world price.