Question

Question is based on the partial equilibrium analysis. Remember to draw relevant graphs for all questions.

1. Canada is a small country that produces and consumes calculators. In free trade, Canada imports calculators from Polynesia, which is also a small country.

Discuss the implications of an export subsidy implemented by Polynesia. Discuss the implications for the country implementing the policy AND its trading partner.

You should clearly discuss production, consumption, exports and imports, and welfare effects (both overall and individual welfare effects).

Answer 1

Both the countries, Canada and Polynesia can make calculators, when Polynesia gives subsidy on the calculators then Polynesian calculators get cheaper in Canada markets. In Polynesia also the calculators will get cheaper and it will reduce imports of Canadian calculators.

Impact on Polynesian market:

As shown in the figure 1 below, it can be seen that subsidy will shift domestic supply to right from Sd to Domestic supply- subsidy, quantity of imports goes down from Q2-Q1 to Q2-Q3, producers receive higher price Ps now. It is clear that producers and consumers in Polynesia are better off but govt. is worse off. More jobs will be produced.

Impact on Polynesian market:

As shown in fig. 2 below, Canada markets will have cheaper imported calculators and hence domestic producers will be worse off but domestic consumers will be better off.Supply curve shifts to right and price for calculators goes down.

In short, market in Canada will be distorted as cheaper imports come, consumption increases but production decreases.

Governments will have to spend more which has opportunity costs and this certainly is a disadvantage for free trade where market mechanism is supposed to allocate resources.

impact on Polynesia sd Domestic supply Domeste supply - subsidy w Od: Domestic demand cly I Q2 ) import after subsidy imports before subsidy 0 Production subsidy & quantity of imports fall. impact fig-(2) market on for canada calculators