Question

This an import quota problem. The nation of Bondago is a ‘small’ island nation and unable to affect world prices. It imports peanuts (island soil is not suitable to grow peanuts due to rising sea level) at the price of $10 per bag. The demand curve is

D = 400 - 10P

and the Supply curve is S = 50 + 5P

Determine the free trade equilibrium. Then calculate (step-by-step) AND graph the following effects of an import quota that limits imports to 50 bags. Note: Use the equations to determine pre-quota quantities, quota limits – all on the horizontal axis (see Figure 9-3 and Figure 9-9 for details). Without an accurate graph, it will be impossible to successfully answer questions (a) – (d).

(a). The increase in the domestic price [15 points (allows for a graph)]

(b) Quota rents (in $s) [10 points]

(c). The consumption distortion loss in $s (identify this on the graph and find the area of the relevant triangle = 1 ( )* 2 base height )[10 points].

(d). The production distortion loss in $s (identify this on the graph and find the area of the relevant triangle = 1 ( )* 2 base height )[5 points]

Answer 1

In free trade, Price, P= $10

D = 400 - 10 P => 400 - 10*10

D= 300

S = 50 + 5 * 10 = 100

Imports = D - S = 300- 100 = 200

Quota: D - S = 50

400-10P - 50 - 5P = 50

350 - 15P = 50

15P = 300

P = $20

D = 400 - 10 * 20 = 200

S = 50 + 5 *20 = 150

Graph

(a) The increase in domestic price is 20 - 10 = $10

(b) Quota rent = (20 - 10 ) * (200 - 150) = 10*50 = $500

(c) Consumption dostortion loss = 1/2 * (20-10) * (300-200) = $500 (Red area)

(d) Producer distortion loss = 1/2 * (20 - 10) * (150-100) = $250 (Black area)