Question

1) Suppose the domestic supply (QS U.S.) and demand (QDU.S) for bicycles in the United States is represented by the following set of equations:

QS U.S. = 2P

QDU.S. = 200 – 2P.

Demand (QD) and supply (QS) in the rest of the world is represented by the equations:

QS = P

QD =160 – P. Quantities are measured in thousands and price, in U.S. dollars. After the opening of free trade with the United States, if the world price of the bicycles settles at $60, answer the following questions:

a. What are the equilibrium price and quantity for US and ROW if there is no international trade? Draw the demand and supply curves on the graph, and label these points.

b. What are the quantities of the import and export if they can trade freely with the price of $60?

c. What is the effect of the shift from no trade to free trade on US consumer surplus? On producer surplus? What is the net national gain or loss for US?

d. Calculate the net benefit for US and ROW after trade to support your answers.

Answer 1

b. After free trade, Euilibrium Price settled at $60, then there arises excess supply 25 units(115-90)in US market but excess demand 55 units (110-55)in ROW. Therefor US will export 25 units to the ROW and ROW will import 55 units.

c. The consumers surplus will decrease in US due to rise in price from $50 to $60 as a result of free trade .But from producers surplus will increase due to rise in price of their products and supply increases to 120 units then before. Thus we can say that both ROW and US wil gain due to the international trade but gain from trade is more in case of ROW as compared to US.

d.US gain =60x25=$1500(producers surplus) and ROW gain=55x60=$3300(consumers surplus).