Question 1: Suppose the supply and demand for Continentia, a large country, is as follows:
D = 900,000 – 150P and S = 100,000 + 50P.
Assume that the free-trade world price is $5,000 per unit. Further assume that the Continentia government offers an export subsidy that increases the domestic market price to $5,500 and lowers the world price to $4,500. However, starting next month, the Continentia government will be removing the export subsidy in compliance with the latest international trade pact.
a. What is the impact of the removal of the subsidy on domestic consumers?
b. What is the change in producer surplus due to the movement to free trade?
c. What is the net effect of moving to free trade on Continentia welfare?
Question 2: Suppose the United States imports 1,000 pounds of bananas from Nicaragua at $0.28 per pound.
Due to a 25% tariff, the consumer price in the United States is $0.35 per pound. Farmers in the United States can provide the bananas at a price of $0.45 per pound. Furthermore, suppose that the proposal to eliminate tariffs on the 50 poorest nations passes. As a result, Angola devotes more resources to the production of bananas and can supply the fruit at $0.40 per pound.
a. Does the proposal lead to trade creation or trade diversion? Explain.
b. If the banana tariff was doubled, would there be trade creation or trade diversion?
c. Assuming that the banana tariff is 50%, what is the net effect of the proposal on U.S. consumers, U.S. producers, U.S. government, and the world welfare?