Question

A large  country imports salt. With free trade at the world price of $10 per pound, the country's national market is as follows:

Domestic production: 100 million pounds per year

Domestic consumption: 200 million pounds per year

Imports: 100 million pounds per year

The country's government now decides to impose a quota that limits salt imports to 40 million pounds per year. With the import quota in effect, the domestic price rises to $13 per pound but as this is a large country, the world price decreases to $8.

At the world price of $8, domestic production is 80 million pound and domestic consumption is 220 million pound.

At the new domestic price of $13, domestic production increases to 130 million pounds per year.

The government auctions the rights to import the 40 million pounds.

Answer the following 3 questions according to this information.

How much is the domestic producers gain or loss from the quota?

How much is the consumer gain or loss?

What is the government revenue?

Answer 1

Gain in producer surplus = area of the region available to producers as a result of quota

= area of the trapezium so formed

= 0.5*(quota price - old world price)*(new domestic production + old domestic production)

= 0.5*(13 - 10)*(130 M + 100 M)

= 0.5*3*30,000,000 = 45 million

Consumers loose a surplus that they had when price was $10. The loss in CS

= 0.5*(quota price - old world price)*(new domestic demand + old domestic demand)

= 0.5*(13 - 10)*(200 M + 170 M)

= 0.5*3*30,000,000

= 45 million.

Government revenue = quota rent = quotas * difference in world price and quota price

= 40 M * 5

= 200 million.