Question

Wheat is freely traded in the world market. Assume that a country, Austria, is a price taker in the world market for wheat. Some of the wheat consumed in Austria is produced domestically while the rest is imported. The world price of wheat is $2 per pound. At the world price, Austria produces 2 million pounds but consumes 14 million pounds. The domestic price is $5. At the domestic price, Austria consumes 8 million pounds of wheat. Austria proposes a $2 tariff on the world price raising the price to $4. At $4, Austria produces 6 million pounds of wheat, but consumes 10 million pounds.

(a) Draw the graph representing the above scenario. Label the appropriate prices and quantities.

(b)Calculate the consumer surplus at the domestic, world, and tariff price and quantity.

(c) Calculate Austria’s tariff revenue.

Answer 1

a) The graph:

(b) consumer surplus :

(i) consumer surplus at domestic price and quantity: ½*4*8 = $16 million
(ii) consumer surplus at world price and qunatity = ½*7*14 = $49 million
(iii) consumer surplus at tariff price and quantity = ½*5*10 = $25 million

(c) tariff revenue = $8 million

tariff revenue = tariff * imports at tariff = 2*4 = $8 million

Note: imports at tariff = demand - supply = 10 - 6 = 4 million