Economic Essay example

2766 Words Mar 21st, 2012 12 Pages
THE INVISIBLE HAND AT WORK

Self-Test Problems

1. Governments sometimes restrict free trade with import quotas, rather than tariffs. Under a quota, foreign goods come into the home country without tariffs, but the quantity allowed to enter is limited. Redraw Application Figure 2, which is in this chapter's Application The Case for Free Trade (in the section Competition and Welfare). Use your diagram to answer the following questions.

a. If a government sets a quota to restrict total imports to q3 − q2 units—what they would have been under the tariff—what impact would this have on the product price for home-country consumers and producers? Explain. b. Under a quota system, the government issues import licenses giving the
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In addition, if the government sells the import licenses at

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it raises the same amount of money with a license system as a tariff. If, alternately, the government issues the licenses for free, foreign producers will prefer a quota to a tariff.

2. Consider the market, composed of many buyers and sellers, depicted in the figure below.

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No one is happy with the equilibrium price in this market, so consumers and producers have each decided to do something about it. Two plans have been proposed.

Plan 1: To avoid a surplus, fix the market price at p1 and forbid firms from producing any more than q1. Plan 2: To avoid a shortage, fix the market price at p2 and require firms to produce q2.

Answer the following questions, and justify your answers carefully.

a. Which plan would consumers prefer? b. Which plan would producers prefer? c. Which of these two plans is better for society?

Answer:

a. Consumers would prefer Plan 2. With plan 1, their consumer surplus is the triangle ABp1, and, with plan 2, their consumer surplus is the triangle ACp2, as shown in the graph below.

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b. Producers would prefer Plan 1. With Plan 1, producer surplus is the area FEBp1. With Plan 2, producer surplus is actually negative. It includes triangle FEp2 – triangle ECG. As ECG appears bigger than FEp2, producer surplus is negative.

c. From society's standpoint, both plans appear to

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