ECON 40710
International Trade
Problem Set 6
Question 1
Suppose Home is a small country. Use the graphs below to answer
the questions.
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Question 1
a)  Calculate Home consumer surplus and producer surplus in the
absence of trade.
1
CSAutarky = (18 − 9)5 = 22.5
2
1
PSAutarky = (9 − 4)5 = 12.5
2
WAutarky = 22.5 + 12.5 = 35
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Question 1
b)  Now suppose that Home engages in trade and faces the world
price, P = $6. Determine the consumer and producer surplus
under free trade. Does Home benefit from trade? Explain.
1
CSTrade = (18 − 6)8 = 48
2
1
PSTrade = (6 − 4)2 = 2
2
WTrade = 48 + 2 = 50
The welfare is higher by 50 – 35 = 15 under free trade
© Antoine Gervais - Fall 2010
Question 1
c)  Concerned about the welfare of the local producers, the Home
government imposes a tariff in the amount of $2 (i.e., t = $2).
Determine the net effect of the tariff on the Home economy.
1
CSTariff = (18 − 8)6 = 30
2
1
PSTariff = (8 − 4)4 = 8
2
G Tariff = (8 − 6)(6 − 4) = 4
WTariff = 30 + 8 + 4 = 42
The welfare is lower by 50 – 42 = 8 compared to free trade
© Antoine Gervais - Fall 2010
Question 2
Refer to the graphs in question 2. Suppose that instead of a tari,
Home applies an import quota limiting the amount foreign can sell
to 2 units.
a)  Determine the net effect of import quota on the Home economy
if the quota licenses are allocated to local producers.
§  Home firms collect the quota rent which is equal to the
tariff revenue.
§  Quota has the same impact as the tariff, so W= 42
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Question 2
b)  Calculate the net effect of the import quota on Homes welfare
if the quota rents are earned by foreign exporters.
In this case, Home does not collect the quota rent.
1
CSQuota = (18 − 8)6 = 30
2
1
PSQuota = (8 − 4)4 = 8
2
WQuota = 38
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Question 2
c)  How do your answers to parts (a) and (b) compare with part (c)
of problem 8?
§  Welfare with tariff is 42
§  Welfare with quota rent given to domestic firms is 42
§  Welfare with quota rent given to foreign firms is 38
§  The welfare is the same with the quota when Home gets the
rent but lower if Foreign firms get the rent
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Question 3
The figure below shows the Home no-trade equilibrium under
perfect competition (with the price PC), and under monopoly (with
the price PM). In this question, we compare the welfare of Home
consumers in these two situations.
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Question 3
a)  Under perfect competition, with the price PC, label the triangle
of consumer surplus and the triangle of producer surplus.
Outline the area of total Home surplus (the sum of consumer
surplus and producer surplus).
CS area is PD PC B
PS is PMC B PC
TS is PD B PMC
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Question 3
b)  Under monopoly, with the price PM, label the consumer surplus
triangle.
CS is PM A PD
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Question 3
c)  Producer surplus is the same as
the profits earned by the
monopolist. To measure this,
label the point in the figure where
the MR curve intersects MC at
point B’.
For selling the units between zero
and QM, marginal costs rise along
the MC curve,up to B’.The
monopolist earns the difference
between the price PM and MC for
each unit sold. Label the
difference between the price and
the MC curve as producer surplus,
or profits.
PS is PM A PD
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Question 3
d)  Compare your answer with parts (a) and (d) and outline the
difference between these two areas. That difference is called
the deadweight loss due to monopoly.
DWL
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Question 4
Consider the case of a Foreign monopoly with no Home
production, shown in the figure below. Starting from free trade at
point A, consider a $10 tariff applied by the Home government.
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Question 4
a)  Assuming that the demand curve is linear, as in problem 10 of
Chapter 6, what is the shape of the marginal revenue curve?
§  The demand curve is given by: P = 100 – Q
§  R = P(Q) Q = (100 – Q) Q = 100 Q – Q2
§  MR = 100 – 2Q
§  The shape of the marginal revenue curve is also linear, but
twice as steep.
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Question 4
b)  Therefore, how much does the tariff-inclusive Home price
increase because of the tariff, and how much does the net-oftariff price received by the Foreign firm fall?
§  Demand curve: P = 100 – Q
à
ΔP = – ΔQ
§  Marginal revenue curve MR = 100 – 2Q
à ΔMR = –2 ΔQ
§  For a given change in Q, the vertical increase along the
marginal revenue curve is twice as much as the
corresponding vertical increase along the demand curve.
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Question 4
§  Since the change in quantity is the
same the increase in price is lower
than the increase in MR
§  The MR increase by the amount of the
tariff (10)
§  Since ΔMR = –2 ΔQ = 10, ΔQ = – 5
§  Therefore ΔP = – ΔQ = 5
§  Thus, the Home tariff-inclusive price
increases by $5 and the net-of-tariff
Foreign price decreases by $5.
© Antoine Gervais - Fall 2010
Question 4
c)  Discuss the welfare effects of implementing the tariff. Use a
graph to illustrate under what conditions, if any, there are
increases in Home welfare.
§  ΔCS = – (c + d)
§  Terms of trade = e
§  Tariff revenue = c + e
§  ΔW = e – d. So welfare increases if e > d
© Antoine Gervais - Fall 2010