Question

Consider a small open economy of Jamaica whose domestic supply and demand of rumis as follows.

Demand: Q= 500−P

Supply: Q= 2.5P−25

where quantity is in thousands of crates and price is in Jamaican dollars (J$).

ii) Now suppose the world price of rum isJ$ 100. In an attempt to protect local rum producers, the government imposes a quota of 105 thousand crates on imports of rum.

a) What will be the local price of a crate of rum, given the quota?

b) What is the value of the consumption deadweight cost associated with the quota?

iii) When the demand for rum changes to Q= 447.5−P, will the deadweight cost decrease or increase? Hint: You do not need to calculate the actual value of the deadweight cost.

Answer 1

Answer.

ii.

a. Now, if government imposes a quota of 105;

Hence, Demand - Supply = 105

500 - P - (2.5P - 25) = 105

525 - 3.5P = 105

3.5P = 420

So, P = 120 and, Q = 500- 120 = 380

b. Now, given the world Price = 100. So, it is the price without quota.

Q without quota = 500 - 100 = 400

Consumer Deadweight Loss = Difference in Quantity with and without quota * Difference in Price with and without quota/ 2 = (400 - 380) * (120 - 100) / 2= 200

iii) Now, if the demand is Q = 447.5 - P, it means that at each price the quantity demanded is will be lower. Hence, the deadweight cost will decrease. In other words, since the demand curve shifts left, deadweight loss will be lower.

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