Question

Assume that the UK car market is perfectly competitive and that cars are a homogenous good. The inverse demand curve for cars is given by PD(Q) = 36−Q, where quantities are measured in millions of units, while prices are measured in thousands of dollars. The supply of cars in the US is given by PS(Q) = 6 + 2Q. Cars are produced also in other countries and in this exercise we will assume that the US is “small” as far as the world car market is concerned. The world market price for cars is given by Pw = 20. (a) What is the UK market price in autarky? (b) Characterize the free trade equilibrium. How many cars are demanded, produced domestically and imported? Calculate the consumer and producer surplus as well as the aggregate welfare associated to this equilibrium. (c) Assume that a tariff of t dollars per car is now introduced. Describe the new equilibrium as a function of the tariff t. What is the new equilibrium price? Compute the consumer and producer surplus, as well as the tariff revenues for the government. In a graph, plot social welfare as a function of the tariff imposed. Which tariff maximizes aggregate welfare? (d) Recently the UK a government has hired McTar, the famous consulting company, to help it determine the optimal trade policy. The company has concluded its study of the problem and has shown that the UK car industry generates a positive spillover on the rest of the UK economy (the workers employed in this industry acquire valuable skills that can be used in other manufacturing sectors). In particular, it has been estimated that each car produced in the US generates a spillover equal to 6 (thousand) dollars. Imported cars of course will not generate this spillover. Assuming that the government continues to levy a tariff t on imported cars, what is the new level of social welfare once we take into account the presence of the spillover? Graphically illustrate the level of social welfare as a function of the tariff. What is the tariff level that maximizes social welfare? Given the existence of this externality is autarky preferable to free trade? What have you learned from this exercise?

Answer 1

put Q:10 in eitheγ ob the demand ,or the 6 2 o Ps(a) -5 26 TAereborethe quant, dem, on d ed at this ana the pice at aa is 26