Econ 1 TA session Ch9 Q5 Week 7 The nation of Textilia does not allow imports of clothing In its equilibrium without trade a T shirt costs 20 and the equilibrium quantity is 3 million T shirts One day after reading Adam Smith s The Wealth of Nations while on vacation the president decides to open the Textilian market to international trade The market price of a T shirt falls to the world price of 16 The number of T shirts consumed in Textilia rises to 4 million while the number of T shirts produced declines to 1 million a Illustrate the situation just described in a graph Your graph should show all the numbers b Calculate the change in consumer surplus producer surplus and total surplus that results from opening up trade Hint Recall that the area of a triangle is 1 2 base height Solution a Figure 1 shows the market for T shirts in Textilia The domestic price is 20 Once trade is allowed the price drops to 16 and three million T shirts are imported Figure 1 Textilia opens up to trade 1 Econ 1 TA session Week 7 b Consumer surplus increases by areas A B C Area A is equal to 4 1 million 0 5 4 2 million 8 million Area B is equal to 0 5 4 2 million 4 million Area C is equal to 0 5 4 1 million 2 million Thus consumer surplus increases by 14 mil lion Producer surplus declines by area A Thus producer surplus falls by 8 million Total surplus rises by areas B C Thus total surplus rises by 6 million Ch9 Q9 600 000 are imported Assume the United States is an importer of televisions and there are no trade restrictions U S consumers buy 1 million televisions per year of which 400 000 are produced domestically and a Suppose that a technological advance among Japanese television manufacturers causes the world price of televisions to fall by 100 Draw a graph to show how this change affects the welfare of U S consumers and U S producers and how it affects total surplus in the United States b After the fall in price consumers buy 1 2 million televisions of which 200 000 are produced domestically and 1 million are imported Calculate the change in consumer surplus producer surplus and total surplus from the price reduction c If the government responded by putting a 100 tariff on imported televisions what would this do Calculate the revenue that would be raised and the deadweight loss Would it be a good policy from the standpoint of U S welfare Who might support the policy d Suppose that the fall in price is attributable not to technological advance but to a 100 per television subsidy from the Japanese government to Japanese industry How would this affect your analysis Solution a When a technological advance lowers the world price of televisions the effect on the United States an importer of televisions is shown in Figure 2 and Table 1 Initially the world price of televisions is P1 consumer surplus is A B producer surplus is C G total surplus is A B C G and the amount of imports is shown as Imports1 After the improvement in technology the world price of televisions declines to P2 which is P1 100 consumer surplus increases by D E F producer surplus declines by C total surplus rises by D E F and the amount of imports rises to Imports2 2 Econ 1 TA session Week 7 Figure 2 TVs Table 1 Surplus changes Consumer Surplus A B A B C D E F C D E F P1 P2 G Producer surplus C G Change C Total Surplus A B C G A B C D E F G D E F b The areas are calculated as follows Area C 200 000 100 0 5 200 000 100 30 million Area D 0 5 200 000 100 10 million Area E 600 000 100 60 million Area F 0 5 200 000 100 10 million Therefore the change in consumer surplus is 110 million The change in producer surplus is 30 million Total surplus rises by 80 million c If the government places a 100 tariff on imported televisions consumer and producer surplus would return to their initial values That is consumer surplus would fall by areas C D E F a decline of 110 million Producer surplus would rise by 30 million The government would gain tariff revenue equal to 100 600 000 60 million The deadweight loss from the tariff would be areas D and F a value of 20 million This is 3 Econ 1 TA session Week 7 not a good policy from the standpoint of U S welfare because total surplus is reduced after the tariff is introduced However domestic producers will be happier as they benefit from the tariff d It makes no difference why the world price dropped in terms of our analysis The drop in the world price benefits domestic consumers more than it harms domestic producers and total welfare improves Ch9 Q10 Consider a small country that exports steel Suppose that a pro trade government decides to subsidize the export of steel by paying a certain amount for each ton sold abroad How does this export subsidy affect the domestic price of steel the quantity of steel produced the quantity of steel consumed and the quantity of steel exported How does it affect consumer surplus producer surplus government revenue and total surplus Is it a good policy from the standpoint of economic efficiency Hint The analysis of an export subsidy is similar to the analysis of a tariff Solution An export subsidy increases the price of steel exports received by producers by 1 units and the country exports the quantity QS the amount of the subsidy s as shown in Figure 3 The figure shows the world price PW before the subsidy is put in place At that price domestic consumers buy quantity QD 1 of steel producers supply QS 1 With the subsidy put in place suppliers get a total price per unit of PW s because they receive the world price for their exports PW and the government pays them the subsidy of s However note that domestic consumers can still buy steel at the world price PW by importing it Domestic firms do not want to sell steel to domestic customers because they do not get the subsidy for 1 QD doing so So domestic companies will sell all the steel they produce abroad in total quantity QS 1 The country imports steel in quantity QD 1 The end result is that the domestic price of steel is unchanged the quantity of steel produced increases 2 Domestic consumers continue to buy quantity QD 1 and exports the quantity QS 2 so net exports of steel are the quantity QS 2 QD the quantity of steel consumed is unchanged and the quantity of steel exported increases As the following table shows consumer surplus is unaffected producer surplus rises government revenue declines and total surplus declines Thus it is …