Economics 102Answers to Class Handout #2Summer 20111. Suppose there is a small, closed economy that produces bananas. The domestic demand and domestic supply curves for bananas in this small, closed economy are givenas:Domestic demand: P = 20 – (1/2)QDomestic supply: P = 2 + (1/10)Qa. (2 points) What is the equilibrium price and quantity of bananas in this small, closed economy?To find the equilibrium price and quantity simply use the demand and supply curves. Thus, 20 – (1/2)Q = 2 + (1/10)Q and solving for Q, we get Q = 30 units. Using this quantity in either the demand or the supply equations we can find the price: P = $5.b. (2 points) Suppose that the world price of bananas is $8 per unit of bananas and this economy opens to trade. Provide a numerical measure of this country’s imports or exports of bananas once the market is open to trade.If the world price is $8 per unit of bananas and this economy opens to trade, then at $8 domestic demanders will demand 24 units of bananas. At $8, domestic suppliers will supply 60 units of bananas. The excess supply of 36 units of bananas will be exported. c. (2 points) If this closed economy opens its banana market to trade with the world price of bananas equal to $8 per unit of bananas, what will be the change in consumer surplus due to this decision?CS when the banana market was closed to trade was equal to (1/2)($20/unit of bananas - $5/unit of bananas)(30 units of bananas) = $225. CS when the banana market is open to trade is equal to (1/2)($20/unit of bananas - $8/unit of bananas)(24 units of bananas) = $144. The loss is consumer surplus when the banana market opens to trade is equal to $81. d. (2 points) Suppose that the world price of bananas is $2.50 per unit of bananas. If this market opens to trade, what will be the level of imports or exports of bananas?1When the world price is $2.50 per unit of bananas domestic demanders will demand 35 units of bananas while domestic suppliers will supply 5 unit of bananas. The excess demand for bananas of 30 units will be met by importing 30 units of bananas into this small economy.e. (2 points) Given the scenario in part (d), what will be the change in consumer surplus when this economy goes from being a closed economy with regard to the banana market to being an open economy with regard to the banana market?CS when the banana market was closed to trade was equal to (1/2)($20/unit of bananas - $5/unit of bananas)(30 units of bananas) = $225. CS when the banana market is open to trade is equal to (1/2)($20/unit of bananas - $2.5/unit of bananas)(35 units of bananas) = $306.25. The gain in CS from opening the market to trade: the gain in CS = $81.25f. (4 points) Suppose that the world price of bananas is $2.50 per unit of bananas and that this economy is open to trade. Suppose the government implements a tariff of $1.00 per unit of bananas. Calculate the tariff revenue from the implementation of this policy and the deadweight loss from the tariff. With the tariff the price of bananas rises to $3.50. At this price 15 units of bananas will be supplied domestically and 33 units of bananas will be demanded domestically. The small country will therefore import 18 units of bananas and collect a tariff of $1/unit of bananas on these imports. Tariff revenue is therefore equal to ($1.00/unit of bananas)(18 units of bananas) = $18. Deadweight loss is equal to (1/2)($3.50/unit of bananas - $2.50/unit of bananas)(15 units of bananas – 5 unit of bananas) + (1/2)($3.50/unit of bananas - $2.50/unitof bananas)(35 units of bananas – 33 units of bananas) = $6. g. (2 points) Suppose the government wishes to replace the tariff described in part (h) with aquota that results in the same consumer surplus as the consumer surplus with the tariff, the same producer surplus as the producer surplus with the tariff, and the same deadweight lossas the deadweight loss with the tariff. How many units of bananas should the quota equal for this result? Explain your answer. With the tariff the small economy imported 4 units of bananas. If the quota was set at 18 units of bananas then the quota would have the same impact as a tariff of $1.00/unit of bananas on consumer surplus, producer surplus, and deadweight loss. 2h. (4 points) Trade has distributional consequences. Briefly summarize who wins and who loses when an economy opens to trade. Be specific in your answer. When an economy opens to trade in a market typically either the world price is greater than or less than the domestic equilibrium price. If the world price is greater than the domestic equilibrium price then the economy that has opened its market to trade will export the good: domestic producers will benefit while domestic consumers will be hurt from this trade. If the world price is less than the domestic equilibrium price then the economy that has opened its market to trade will import the good: domestic producers will be hurt while domestic consumers will benefit from this trade. 2. Suppose there are two countries, Capriland and Melodia. Both countries produce two goods, pianos and cars. Furthermore, assume that both countries have linear production possibility frontiers (PPFs). The following table provides information about the amount of labor necessary to produce one piano or one car in each of these two countries. Assume that Capriland and Melodia both have a total of 120 hours of labor available to devote to the production of pianos and cars. (Hint: put pianos (P) on the vertical axis and cars (C) on the horizontal axis as your workthe various parts of this problem.)Labor Needed to Produce One Piano Labor Needed to Produce One CarCapriland 2 hours of labor 10 hours of laborMelodia 4 hours of labor 12 hours of labora. (2 points) Given the above information, write an equation that represents Capriland’s PPF. In your equation pianos should be abbreviated as P and cars should be abbreviated as C. Answer:With 120 hours of labor Capriland can produce 60 pianos and 0 cars or 12 cars and 0 pianos. Using these two points we can write an equation for Capriland’s PPF as P = 60 – 5C. This equation could also be expressed as C = 12 – (1/5)P.3b. (2 points) Suppose that the amount of labor available for the production of pianos and cars is now 60 hours. You are told that Melodia is currently producing on its PPF and Melodia is producing 3 cars. Calculate how many pianos Melodia is making. Answer:Melodia’s PPF can be written as P = 15 – 3C if
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