Assignment # 5 Due December 1st (beginning of class)

Assignment # 5

Due December 1st (beginning of class)

Suppose that England's demand for wine is given by the following equation : QD = 14,000 - 2,000P where QD is quantity demanded and P is the price of wine while its domestic supply is given by:

QS = 2,000P - 2,000 where QS is quantity supplied.

a. Calculate the equilibrium autarky price of wine: $4 Calculate the equilibrium quantity in autarky: 6.000

b. From autarky to free trade

Now assume that England allows free trade and buys its wine for $ 2 per bottle. i. Calculate the new level (quantity) of consumption: 10,000 ii. the new level (quantity) of production 2,000 iii. the level (quantity) of imports 8,000

iv. the value of imports $16,000 v. the net welfare change (+ for gain or - for loss) +$8,000

ii. the change (quantity) in production 3,600-2,000=+1,600 (include sign)

iii. the change (quantity) in imports New imports: 8,400-3,600 = 4,800 change: 4,800-8,000 = -3,200 (include sign)

iv. the tariff revenues 4,800 * $1 = $4,800 v. the net welfare change (+ for gain or - for loss) broken down into its components

gain: 4,800 * $.2 = $960 loss: (1,600 * $.8)/2 + (1,600 * $.8)/2 = $1,280

net: $960-$1,280 = - $320

d. From free trade to production subsidy

This a large country case so the production subsidy will depress the world price of wine, the import good; basically RS shifts while RD does not in chapter 5 approach. Had England used a $1 production subsidy instead of a tariff to help its wine industry, speculate (do not calculate) on what would happen to English (quantity when relevant): consumption Increases decreases stays the same unknown domestic production Increases decreases stays the same unknown imports of wine Increases decreases stays the same unknown terms of trade Improves deteriorates stays the same unknown domestic price Increases decreases stays the same unknown

Problem 2. Use the graph below to show the effect of a (specific) subsidy on wheat exports set by the EU.

EU market for wheat P S 262.5 250 237.5 200 D 2,000 450 500 2,300 2,500 2,750 Q Autarky price: $200

World price (before subsidy); $250

Size of subsidy; $25

Quantity traded before subsidy: 2000 Domestic demand before subsidy: 500

As a result of the subsidy assume that the domestic price changes by 5%, the quantity traded changes by 15% and demand changes by 10%.

What is the domestic price $250*1.05 = $262.5 the world price $262.5-$25 = $237.5

the change in the quantity traded 2,300-2,000 = +300 (sign) the change in demand -50 (sign)

the change in production +250 (sign)

the cost of the subsidy to the government $25*2,300 = $57,500

the deadweight loss on the consumption side ($12.5*50)/2 =$312.5

the deadweight loss on the production side ($12.5*250)/2=$1,562.5 the cost of the subsidy due to decrease in Px $12.5*2,300 = $28,750

the total welfare cost of the subsidy $30,625

Problem 3. Assume that a small country switches from an import tariff (original situation) to a import quota that continues to offer exactly the same amount of protection to the industry. The free trade price is $20,000 and the original specific tariff is $2,000.

P D D’ S

22,000 20,000

100 110 150 170 190 210 Q

The quota is allocated to the importers on a first come first served basis and the demand is represented by the solid D curve. .

Use the graph above to calculate the following: Size of the quota 40

value of the quota rent $80,000 who gets it? importers

Use the above graph to compare the impact of the quota to the impact of a tariff. Recalculate:

Imports with quota 40 Imports with tariff 80

Problem 4. Assume that an open economy produces bicycles, but must import the wheels (2 wheels per bicycle). The free trade price of bicycles is $500 and the free trade price of wheels is $50 (per wheel).

Suppose that the tariff on bicycles is 15% and the tariff on wheels is 20%. a. Calculate the effective rate of protection.

DVA = $500 - $100 = $400 ERP = (455-400)/400 = 13.75% DVA w/ tariff = $575 - $120 = $455

b. Which tariff structure would maximize the effective rate of protection? Tariff on bicycle and zero tariff on imported components (wheels)

c. Calculate the maximum rate of effective protection (assuming a 10% tariff on bicycles).

DVA = $400 and DVA w/ tariff on bicycle only = $450 ERP = (450-400)/400 = 12.5%

d. Which tariff structure would result in a zero rate of effective protection (still assuming a 10% tariff on bicycles)?

DVA w/ tariff = DVA 550 – X = 400

X (wheels including tariff) = 150