Question

Include correctly labeled diagrams, if useful or required, in explaining your answers. A correctly labeled diagram must have all axes and curves clearly labeled and must show directional changes. If the question prompts you to "Calculate," you must show how you arrived at your final answer.

In the small country of AgroIsland, the equilibrium price of wheat is $10$10 per bushel. Wheat is produced in a competitive industry. The world market price of wheat is $20$20 per bushel.

(a) Assume that AgroIsland currently does not engage in international trade in wheat. Draw a correctly labeled graph to illustrate the market for wheat in AgroIsland and indicate the following.

(i) The equilibrium price, labeled $10$10

(ii) The equilibrium quantity, labeled Q∗Q*

(iii) The domestic producer surplus, shaded completely and labeled PSPS

(b) On the graph from part (a), show each of the following for AgroIsland if it engages in free trade in the world wheat market.

(i) The world price of a bushel of wheat, labeled $20$20

(ii) The quantity of wheat supplied by domestic producers, labeled QPQP

(iii) The domestic consumer surplus after trade, shaded completely and labeled CSCS

(c) Given your answers in part (b), how does each of the following change if AgroIsland engages in international trade in the wheat market?

(i) The domestic consumer surplus

(ii) The domestic producer surplus

Answer 1

(a) Agroland's domestic market:

  
D is the demand curve; S is the supply curve. Price = $10; Quantity = Q*. Producer surplus (PS) is above the supply curve and below the equilibrium price.

(b) Agroland's free trade:

World price= $20 (higher than domestic price. So, supply increases to QP. Due to increased price, consumer surplus decreases to the area of CS.

(c) Effect of international trade: Due to international trade,
(i) The domestic consumer surplus decreases,
(ii) The domestic producer surplus increases.

The final picture: (Not asked in the question. Just for clarification).