Question

3. Consumer Surplus and Producer Surplus from Market Exchange

Consider the Zambian market for oranges.

The following graph shows the domestic demand and domestic supply curves for oranges in Zambia. Suppose Zambia's government currently does not allow the international trade in oranges.

Use the black point (plus symbol) to indicate the equilibrium price of a ton of oranges and the equilibrium quantity of oranges in Zambia in the absence of international trade. Then, use the green point (triangle symbol) to shade the area representing consumer surplus in equilibrium. Finally, use the purple point (diamond symbol) to shade the area representing producer surplus in equilibrium.

Note: Select and drag a fill area point from the palette to the graph. To fill in regions on the graph, merely drop the fill area point on the desired region.

Based on the previous graph, total surplus in the absence of international trade is _________ million.

The following graph shows the same domestic demand and supply curves for oranges in Zambia. Suppose that the Zambian government changes its international trade policy to allow the free trade of oranges. The horizontal black line (PW) represents the world price of oranges at $700 per ton. Assume that Zambia's entry into the world market for oranges has no effect on the world price and there are no transportation or transaction costs associated with international trade in oranges. Also assume that domestic suppliers will satisfy domestic demand as much as possible before any exporting or importing takes place.

Use the green point (triangle symbol) to shade consumer surplus, and then use the purple point (diamond symbol) to shade producer surplus.

1580Domestic Demand Domestic Supply 1470 No Trade Equilibrium 1360 1250 d 1140 Consumer Surplus 1030 0 Ш 920 0 Producer Surplus a 810 700 590 480 0 35 70 105 140175 210 245 280 315 350 QUANTITY (Thousands of tons of oranges) 1580Domestic Demand Domestic Supply 1470 Consumer Surplus 1360 1250 1140 Producer Surplus O 1030 920 a 810 700 0 35 70 105 140 175 210 245 280 315 350 5 2 QUANTITY (Thousands of tons of oranges) When Zambia allows free trade of oranges, the price of a ton of oranges in Zambia will be $700. At this price, tons of oranges will be demanded in Zambia, and tons will be supplied by domestic suppliers. Therefore, Zambia will import tons of oranges. Using the information from the previous tasks, complete the following table to analyze the welfare effect of allowing free trade. Without Free Trade With Free Trade (Millions of dollars) (Millions of dollars) Consumer Surplus Producer Surplus When Zambia allows free trade, the country's consumer surplusbyn $million. So, the net effect of international trade on Zambia's total surplus is a S mil llion, and producer surplus million by of $

Answer 1

Answer:

In pre-trade equilibrium, domestic demand and supply curves intersect.

Consumer surplus (CS) = Area between domestic demand curve and price = Area AEP0

Producer surplus (PS) = Area between domestic supply curve and price = Area BEP0

1580Domestic Demand Domestic Supply 1470 No Trade Equilibriunm 1360 1250 1140 Consumer Surplus Po UD 1030 920 810 700 Producer Surplus 590 480 35 70 105 140 175 210 245 280 315 350 QUANTITY (Thousands of tons of oranges)

Total surplus (TS) = CS + PS = Area AEB = (1/2) x $(1580 - 480) x 175 = $96,250

1580 Domestic Demand Domestic Supply 1470 Consumer Surplus 1360 1250 E 1140 Producer Surplus D 1030 Ш 920 a 810 700 Pw 590 480 B035 70 105 140 175 210 245 280 315 350 QUANTITY (Thousands of tons of oranges)

With trade, relevant price is Pw (= $700).

New CS = Area APwD

New PS = Area BPwC

(4) At Pw = $700,

Quantity demanded = 70

Quantity supplied = 280

Exports = 280 – 70 = 210

(5)

(i) Without free trade,

CS = (1/2) x $(1580 - 1030) x 175 = $48,125

PS = (1/2) x $(1030 - 480) x 175 = $48,125

(ii) With free trade,

CS = (1/2) x $(1580 - 700) x 280 = $1,23,200

PS = (1/2) x $(700 - 480) x 70 = $7,700

When Kenya allows free trade, CS increases by $75,075 (= 123,200 – 48,125), PS decreases by $40,425 (= 48,125 – 7,700). So net effect on total surplus is a gain equal to $34,650 (= Increase in PS - Decrease in CS = $75,075 - $40,425).