Question

In the taorine, demand for rice can be described by P = 100-Q and the country's cost of producing vegetables is mc = 2 + Q. The world market has a perfect elastic price for rice of 40. Taoretien has had free trade with the outside world but intends to introduce a customs duty on vegetables to 10. Illustrate the situation graphically, calculate trade volumes before and after customs was introduced. illustrate and calculate the welfare benefits of the customs for all groups within the country.

Answer 1

The situation is shown in the graph below where before duty trade volume was (60 - 38) = 22 units and after duty volume of trade (50 - 48) = 2 units.

Initial consumer surplus is (A + B + C + D + E + F) = 0.5*(100 - 40)*60 = 1800

and after duty consumer surplus is (A + B) = 0.5*(100 - 50)*50 = 1250. Welfare of consumer falls by 550

Initial producer surplus = (G) = 0.5*(40 - 2)*38 = 722 and after duty producer surplus = F + G = 0.5*(50 - 2)*48 = 1152. Hence welfare of producer rises by 430

Government earns a revenue of C = 10*2 = 20. and there is a welfare loss of = (-550 + 430 + 20) = -100.