SolutionsPractice Problem Set #5 ECO 3704: International Trade Elias Dinopoulos Problem 1 Foreign’s demand curve for wheat is D* = 80-20P. Its supply curve is S* = 40 + 20P. Suppose Foreign is a small country a. Graph the demand and supply curves. P S* 4 P* = 1.5 P=1 D* Q 40 50 80 70 b. In the absence of trade, what would the price of wheat be in Foreign? In the absence of trade: D* = S*. Thus, 80 – 20P = 40 + 20P. This implies P = 1. c. The price of wheat in the world market is 1.5. What is the free-trade equilibrium price of wheat in Foreign? 1 5 = 70.Free-trade price in a small country = world price = 1.5 = 50. a. b. domestic consumption. Determine the amount of domestic production.75 P* = 1.75. Domestic consumption = 80 – 20*1. P = P*(the world price) = 1. Problem 2 In the example of problem 1.75 = 75.25 = 1. Domestic production = 40 + 20*1. Exports = Domestic production – Domestic consumption = 70 – 50 = 20.75 = 45.25 per unit.5 P=1 D* Q 40 45 50 70 75 80 Domestic price = P* + s = 1. P S* 4 P = 1. Determine using a graph the effect of the export subsidy on the welfare of each of the following groups: 2 . suppose Foreign offers exporters a subsidy of 0. d. Domestic production = 40 + 20*1.5. and exports of wheat in Foreign under free trade. Domestic consumption = 80 – 20*1. Under free trade. Determine and graph the effects of the subsidy on the price of wheat and the quantity of wheat supplied and demanded in Home.5 + 0.5. P S* 4 C P = 1.5 A F E D G B F F D* 0 40 45 50 Q 70 75 80 (1) Foreign producers benefit from the export subsidy since producer surplus increases from (F +G) to (B+C+D+F+G).5)(50 45) 0.625 . c.75 1. and the net welfare effect of the export subsidy. (3) the Foreign government. A large country may benefit from a tariff because the terms-of-trade gains from the tariff may outweigh the distortion losses caused by the tariff.625 .(1) Foreign wheat producers. (2) Foreign consumers lose from the export subsidy since consumer surplus reduces from (A+B+C) to A. 2 Net welfare loss areas(C E ) 1. the consumption distortion loss. the production distortion loss.5)(75 70) Production distortion loss areaE 0. 3 . (3) Foreign government spends (C+D+E) to finance the export subsidy. Calculate.75 P* = 1. Consumption distortion loss areaC Problem 3 “ A large country may benefit from a tariff. using geometric techniques.25 . (2) Foreign consumers. True.75 1.” True or false? Give a short explanation . (1. 2 (1. Problem 4 At the price of $10 per bag of peanuts. The following figure illustrates the free-trade equilibrium. The quota rents are ($20-$10)50 = $500.5 . Without trade domestic prices and quantities adjust such as the excess (import) demand is zero: 80 40P . the amount of exports supplied XS* must be equal to the amount of imports demanded MD. So.. To find this substitute the world price in the supply and demand curves and calculate the excess demand curve: D S [400 10 P] [50 5P] 350 15P . A quota limiting the imports of peanuts to 50 bags has the following affects: a. The production distortion loss is equal to the area of the corresponding triangle: 0. setting MD = XS* yields 80 40 P 40 40 P which in turn generates the world price PW 1. The price of peanuts rises to $20 per bag.5 (100 bags)($10 per bag)=$500. The demand curve implies that an increase in the price of peanuts of $10 decreases the quantity demanded by 100 units. Problem 6 a. The supply curve implies that an increase in the domestic price of $10 increases the quantity supplied by 50 bags. c. Problem 5 The import demand equation MD is found by subtracting the home supply equation from the home demand equation: MD D S 100 20 P 20 20 P 80 40 P . 4 . Under free trade. Thus. b.e. so setting XS*=0 and solving for the price yields 40=40P which generates the foreign autarkic price: P*=1 b. Substituting this price into the import demand (or export supply) yields the volume of trade: 20 units. The consumption distortion loss is equal to the area of the corresponding triangle: 0. D S 50 350 15P which implies P 300 /15 20 ). in the absence of trade. In the absence of trade foreign does not export. the home price is P=2. To find this calculate the excess demand for peanuts and find the price which corresponds to an excess quantity demanded of 50 bags ( i.5 (50 bags)($10 per bag)=$250. The foreign (as opposed to home) export supply curve XS* is found by subtracting from the foreign supply the foreign demand curve: XS * S * D* 40 20 P [80 20 P ] 40 40 P . d. Acirema imports 200 bags of peanuts. 5 P=1 MD Q 80 20 5 .P XS* P=2 PW 1.