Question

. A foreign country produces and subsidizes Good Z. The subsidy causes the world price with the subsidy to be below the world price without the subsidy. For the parts below, analyze what happens when the foreign country stops its subsidy of Good Z. [You don’t need graphs for this question.]

(a) Consider the effect on a small domestic country that produces and exports Good Z. What happens to its consumer surplus, producer surplus, and total surplus for Good Z?

(b) Consider the effect on a small domestic country that produces and imports Good Z. What happens to its consumer surplus, producer surplus, and total surplus for Good Z?

(c) Consider the worldwide effect. What happens to the world total surplus for Good Z?

Answer 1

Answer A. When the foreign country stops its subsidy on product Z the world price of the product Z will increase and worldwide the producer will be in status quo. The small country which exports the product Z will see the producers surplus increasing while consumer surplus will decrease.

B. When the foreign country stops its subsidy on product Z the world price of the product Z will increase and worldwide the producer will be in status quo. The small country which imports the product Z will see the producers surplus increasing while consumer surplus will decrease.

C. Worlds total surplus will remain same but redistribution will happen from the producer of foreign country to producers of the other countries.