PRICES & MARKETS Tutorial 4 International Trade

Quiz Answers
Q1: b. Q2: a. Q3: c. Q4: c. Q5: a.

Group Exercise
Solution to Question 1: The demand and supply curves for bananas are given by the following formulas, QD = 70 2P and QS = 10 + 2P, where P is price per kilogram of bananas in dollars, and Q is quantity of bananas measured in thousands (000) of kilograms. (a) See gure 1. P 6 35 Supply 25 20

World Price

Demand
-

10

20

30

40

70 Q

Figure 1: The Market for Bananas (b) In equilibrium QD = QS thus, 70 2P = 10 + 2P 4P = 80 P = $20. 1

Substituting into the demand curve Q = 70 2 20 = 30 or 30,000 kilograms. (c) At the world price consumer demand QD = 70 2 25 = 20 while producers supply QS = 10 + 2 25 = 40 thus the net exports from this market are 20,000 kilograms of bananas. The gains from trade are, 1 Gains from Trade = Base Height 2 1 = (40 20) (25 20) 2 = 50, or $50,000. (d) At the world price consumer demand QD = 70 2 15 = 40 while producers supply QS = 10 + 2 15 = 20 thus the net imports into this market are 20,000 kilograms of bananas. The gains from trade are, 1 Gains from Trade = Base Height 2 1 = (40 20) (20 15) 2 = 50, or $50,000. P 6 35 Supply

20 17.5 15

Local Price

World Price

Demand
-

25

35

10

20

30

40

70 Q

Figure 2: The Market for Bananas (e) The tari raises the local price to $17.50. At the local price consumer demand QD = 70 2 17.5 = 35 while producers supply QS = 10 + 2 17.50 = 25 thus the net imports into this market are 10,000 kilograms of bananas. The tari revenue

is 2.5 10 = $25, 000. The dead weight loss is, DWL = 1 1 (17.5 15) (25 20) + (17.5 15) (40 35) 2 2 = 6.25 + 6.25 = 12.5,

or $12,500. Solution to Question 2: Opening a market to free trade allows countries to exploit their respective comparative advantages, generating gains from trade. If the world price is above the local price suppliers benet, receiving the higher price for their local sales, and selling their excess production into the world market. Consumers suer as a consequence of the price increase. If, on the other hand, the world price is below the local price consumers benet. They purchase the product for a lower price, sourcing their excess demand from the world market. Producers suer as a consequence of the price decrease.