Question

9.21) Suppose the domestic demand equation for a widget is given by Q = 80 – 2P and the domestic supply equation is Q = -10 + P.

a) Assume there is free trade and the world price of the widget is 20 liras. How many units of this widget will be imported?

b) Calculate the change in the consumer supply and producer supply if the government applies a 5 liras per unit tariff on the product. What will be the governments tariff revenue? How much will the resulting deadweight loss be?

Answer 1

Demand: Q=80-2P

Supply: Q=-10+P

a) When the price is 20

QD = 80-2(20) = 40

QS= -10+20 = 10

Imports = 40-10 =30

b) The tariff will increase the price to 25

With tariff,Quantity Demanded=80-2(25) = 30

Quantity Supplied =-10+25 = 15

Maximum reservation price = 80/2=40

Minimum reservation price = 10

CS with free trade = 0.5*40*(40-20) = 400

PS with free trade = 0.5*10*(20-10) = 50

CS with tariff = 0.5*30*(40-25) = 225

PS with tariff = 0.5*15*(25-10) = 112.5

Government Revenue = 5*(30-15) = 75

DWL = 0.5*(15-10)*5 + 0.5*(40-30)*5 = 12.5+25 = 37.5