A small country can import a good at a world price of 10 per unit. The domestic
supply curve of the good is
S = 20 + 10P
The demand curve is
D = 400 – 5P
In addition, each unit of production yields a marginal social benefit of 10.
a. Calculate the total effect on welfare of a tariff of 5 per unit levied on
imports.
S= 20+10(10) = 120
D= 400-5(10) =350
M=S-D 120-350= 230
b. Calculate the total effect of a production subsidy of 5 per unit.
c. Why does the production subsidy produce a greater gain in welfare than
the tariff?
d. What would the optimal production subsidy be?