Question

Malaysia is an exporter of natural rubber. Initially, the world price of natural rubber is RM5 per kilogram. It costs RM1 per kilogram (on average) to transport natural rubber from Malaysia to overseas, and Malaysian natural rubber exporters pay these transport costs. So Malaysian natural rubber producers only receive RM4 per kilogram after they pay for transport. (a) Using a diagram, illustrate the demand and supply in the Malaysian natural rubber market. What is the domestic price of natural rubber (per kg) in Malaysia? Show the areas of consumer surplus and producer surplus that is created in Malaysia from the production and sale of natural rubber. Be sure to label your diagram carefully. [4 marks] (Hint: Malaysian natural rubber producers do not have to pay for the transportation cost if they sell their products domestically) (b) Suppose the Malaysian government decides that it is unfair for natural rubber producers to pay for transporting natural rubber overseas. To help natural rubber producers, the government 3 decides to pay domestic natural rubber producers RM1 for every kilogram of natural rubber that they export. The government does not pay any money for natural rubber sold in Malaysia. On a new diagram, show the effect of this government policy. How does it affect the price of natural rubber in Malaysia? What are the effects on consumer surplus, producer surplus, and government revenue? Does the policy lead to a deadweight loss? If so, illustrate the loss and explain what it means. If not, explain why the policy does not lead to a deadweight loss. Be sure to fully explain your answer. [6 marks]

Answer 1

Ans(a) The domestic price will be decided by demand and supply in the Malaysia economy only. While the world price will be decided by international market. The world price is less then domestic price because in world market they have to compete with lager market then the domestic and demand is higher. So the world price is shown below domestic price in the figure.

P= domestic price

P*= world's price

Q= domestic quantity

Q*= world's quantity

C.S = total consumer surplus

G.R = government revenue ( Malaysia)

P.S = producer surplus

E = equilibrium point

Q1= quantity supplied in international market

Consumer surplus is the area below the demand curve in this figure it is total area which is enjoyed by both consumer i.e by domestic as well as international. Similarly producer surplus is the area below supply curve. Government revenue is the area which the producer have to pay in transportation cost. The quantity demanded in international market is Q* at this price but Malaysia can supply Q1 quantity at that price because if they will supply more then they will face loss in the market. The domestic price is higher because the transportation cost will be earn by Malaysian by domestic price as the demand in domestic market is also higher then international market.

Ans (b) In this situation if the government give RM1 to the exporter then the situation of dead weight loss will occur. The transportation cost will work as if there is price ceiling in the international market because government know the price in the international market producer have to pay less to govt as their transportation cost is reduce but this amount will go no where it will not enjoyed by consumer as they are paying the same amount as before.

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Now the producer have to pay less but they can't receive more from international market because this can effect their whole demand if they will increase price so the price is fixed in the international market. The quantity demanded is less in international market.