Question

Trade barriers

Suppose there are only two countries in the world (Home and Rest of the World) which produce and consume wheat. The price of wheat in Rest of the World is equal to 2 and Home is a small country with the following demand and supply functions for wheat:

?h = 50 − 10?

?h = 30 + 10?

a. Compute and graph the equilibrium in the absence of trade. What would be the consumer and producer surplus? b. Now allow Home and Rest of the World to trade, assuming zero transportation cost. Find and graph the equilibrium under free trade. What would be the consumer and producer surplus changes? Now Home country imposes a tariff of 20% on wheat exports. c. Determine and show graphically the effects of the tariff on: (1) The price of wheat in each country; (2) The quantity of wheat supplied and demanded in Home.

Answer 1

Equilibrium is attained where quantity demanded of good is equal to its quantity supplied.

When world price is above equilibrium price of home country then consumers are willing to buy less while sellers are willing to sell more of goods. This causes surplus of goods in the market.

Consumer surplus is the area below demand curve and above market equilibrium price. Producer surplus is the area below market price and above supply curve.