EC 340 Study Guide - Midterm Guide: Preferential Trading Area, Free Trade, Nash Equilibrium

Trade Policy.

The demand for cars in Home is q = 30 – P and the supply of cars in Home is q = P. The demand for cars in Foreign is q = 10 – P and the supply of cars in Foreign is q = P.

a) Calculate the autarky equilibrium price and quantity in each country.

b) Who is the importer of cars and who is the exporter?

c) Write the import demand for Home and the export supply for Foreign.

d) Find the equilibrium world price under free trade. What is the amount of cars traded between the two countries?

e) Suppose the country that is the importer imposes a tariff of $2 per unit on car imports. Find the new equilibrium world price under the tariff. What is the amount of cars traded between the two countries now? Show this in a graph with the import demand for Home and the export supply for Foreign.

f) Look at figure 1 for Home and fill in the table below (with letters, no numbers) with the consumer surplus, producer surplus, government revenue and total surplus before and after the tariff.

g) Look at figure 2 for Foreign and fill in the table below ((with letters, no numbers) with the consumer surplus, producer surplus, government revenue and total surplus before and after the tariff.

h) Does Home experience a terms of trade gain or loss as a result of the tariff? Does Foreign experience a terms of trade gain or loss as a result of the tariff?

Under a binding price ceiling, what does the change in consumer surplus represent?
A) The gain in surplus for those buyers who can still purchase the product at the lower price.
B) The loss in surplus for those buyers who previously purchased some units of the good at the higher price, but these units are no longer produced at the lower price.
C) The loss in surplus for those buyers who would like the purchase the excess demand created by the price ceiling policy.
D) Both A and B are correct.
E) Both A and C are correct.

When the market price is held above the competitive level, the deadweight loss is composed of:

A) producer surplus losses associated with units that used to be traded on the market but are no longer exchanged.

B) consumer surplus losses associated with units that used to be traded on the market but are no longer exchanged.
C) producer and consumer surplus losses associated with units that used to be traded on the market but are no longer exchanged.
D) There is no deadweight loss if the government uses a price floor policy to increase the price.

Compared to a tariff, an import quota, which restricts imports to the same amount as the tariff, will leave the country as a whole
A) worse off than a comparable tariff.
B) not as bad off as a comparable tariff.

C) about the same as a comparable tariff.

D) Any of the above can be true.

What is the welfare impact of a subsidy policy?
A) Producer surplus increases, consumer surplus declines, and total welfare declines.
B) Producer and consumer surplus increase, and these gains are larger than the government cost.

C) Producer and consumer surplus increase, and these gains are smaller than the government cost.

D) Producer surplus increases, consumer surplus declines, and total welfare increases due to the subsidy program.

Why is there a deadweight loss associated with subsidy payments?
A) There is no deadweight loss from a subsidy.
B) Quantity supplied is less than the equilibrium amount, so consumers and producers lose surplus value on those units that are no longer produced.
C) Quantity supplied exceeds the equilibrium amount, and consumer willingness to pay for these additional units is smaller than the marginal cost of producing them.
D) The subsidy payment does not distort quantities in the market, but the government cost exceeds consumer willingness to pay for the quantity demanded.

1) Taxing a monopoly (20 Points) Suppose that a monopolist sells a product to consumers with an aggregate demand that is downward sloping in quantity, D(Q) = 200 − 2Q. The total cost of producing Q units is C(Q) = 20Q + 2Q2 .

a) Identify the unregulated equilibrium (P ∗ , Q∗ )

b) What are the consumer and producer surpluses (CS and PS) and total welfare (W) at this equilibrium?

c) Suppose that a specific tax of τ = 20 is imposed on each unit. i. What price-quantity pair (P 1 , Q1 ) would we expect? ii. What are CS, PS, tax revenue (T), and W? iii. What is deadweight loss?

d) Instead of a specific tax, an ad valorem tax, α = 16 is imposed i. What price-quantity pair (P 2 , Q2 ) would we expect? ii. What are CS, PS, T, and W? iii. What is deadweight loss?

e) Welfare distribution i. Which scenario results in the highest producer surplus? ii. Which scenario results in the greatest gains for consumers, assuming that all tax revenues are perfectly redistributed to consumers only.