The following diagram shows the domestic demand and domestic supply curves in a market. Suppose the world price in this market is $6. Assume the country allows free trade. a. Who does free trade benefit? Quantify this using consumer or producer surplus. Show calculations. b. Who does free trade harm? Quantify this using consumer or producer surplus. Show calculations. c. Overall, does this benefit or harm society? How do we quantify this - show me. Interpret the result.
Homework Answers
When there is no trade, equilibrium price is $4 and equilibrium quantity is 20.
Before tax, Consumers surplus (the area below the demand curve and above the price) = (1/2) * 20 * (8 - 4) = $40.
Producers surplus (the area below market price and above the supply curve) = (1/2)*20*(4 - 0) = $40
Total surplus = Consumers surplus + producers surplus = $(40+40) = $80
After tax, when price = $6, Consumers surplus = (1/2)*10*(8-6) = $10
Producers surplus = (1/2)*30*(6-0) = $90
Total surplus = $(10+90) = $100
So after tax, producers are benefitted as producer's surplus increases by $(90 - 40) = $50. Consumers are harmed from trade because trade decreases CS by $(40 - 10) = $30.
However, trade benefits the society as a whole by increasing total surplus by $(100 - 80) = $20
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