Question

Consider a closed economy. Suppose the market for corn in banana republic is competitive. The domestic market demand function for corn is Qd=18 -P and the domestic market supply function is Qs=P-2, both measured in billions of bushels per year. In order to help the corn industry, the government initiated a price support program by purchasing 2 billion bushels corn in the market.

a) draw a graph to show the new market equilibrium price and quantity without calculating the number. Identify the area of the deadweight loss on the graph.

B) can you calculate the new market equilibrium price and quantity? Now consider a small open economy. The domestic supply and demand functions are the same as before. Also, assume the import supply curve is infinitely elastic at a price of $4 per bushel.

C) (5 marks ) suppose the government imposes a tariff of $3 per bushel. Calculate the new equilibrium price and quantity. Calculate the total willingness to pay of the domestic consumers, domestic producer surplus and deadweight loss.

Answer 1

A)

B) We need to calculate the price , where excess supply is 2 billion.

Excess supply= Qs- Qd=p-2-(18-p)=2p-20

2=2p-20

P=22/11=2

So new equilibrium price is 11.

New Equilibrium quantity:Qs=p-2=11-2=9

C) without import, equilibrium price:

Qd=Qs

18-p=p-2

P=16/2=8

With import but no tariff equilibrium price= world price or import price=4$

After 3$ tariff , world price =4+3=7$

Because even after tariff world price is lower than closed economy equilibrium price (8).

So new Equilibrium price =7$.

Equilibrium quantity:Qd=18-p=18-7=11

Consumer surplus=1/2*11*(18-7)=0.5*11*11=60.5

Quantity sold by domestic producers=p-2=7-2=5

Domestic producers surplus=1/2*5*(7-2)=0.5*5*5=12.5

At World price=4$, Qd=18-4=14

And Qs=4-2=2

Deadweight loss=1/2*3*(5-2) +1/2*3*(14-11)=0.5*3*3 +0.5*3*3=2*0.5*3*3=9