Question

Price So 1 Po PwT Pw 4 5 9 10 6 7 11 12 13 14 Do Qi 2 0 04 Qs Qantity The graph above depicts the domestic market for good X. Domestic demand and supply are represented by DD and So respectively. The domestic price is Po and the world price is Pw. The price Pw-T, represents the world price plus a tariff. If the domestic country's government wanted to maximize total surplus then O the government should impose the tariff as the gains in tariff revenue offset any welfare losses the government should allow free trade as it provides the greatest gains to consumer surplus opposed to the autarky domestic price and the world price with the tariff. O the government should not allow free trade and instead choose the autarky domestic price as greater gains from specialization occur in autarky O the government should allow the world price to prevail as tariff revenue can be collected at Pw offsetting any effects from the loss of producer surplus.

Answer 1

At Pd levels, there is no specific maximization of either Consumer or Producer surplus. At Pw levels, the maximization occurs for the Consumer surplus at the expense of Producer surplus, If this is allowed to prevail in domestic market, the domestic firms will be worst hit, and supply needed to increased. If free trade continues, there is not a big hit over domestic firms while the Consumer surplus is maximized highest, this is the best scenario for all(Option B). If the governement applies tariff, there will be an incremental tariff revenue( 12 & 13) but it will be consumed by the societal losses at (11 & 14). It also doesn't increase the Overall surplus over the value in Option B. Hence, option B can provide the maximum value of Total Surplus.