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Effect of Free Trade, Tariffs and Quotas on the Sugar Market

Tasmania is a small region. Suppose the following equations characterize Tasmania's demand (Qd) and supply (Qs) for sugar:
Qd = 100 - P
Qs = P
The price of sugar in world markets is PW = $20

a) What would be the equilibrium price in Tasmania's sugar market if imports were totally restricted?
b) If Tasmania opens its sugar market to free trade will it import or export sugar?
c) How much sugar will it import or export under free trade?
d) Now suppose the government of Tasmania imposes a tariff of 20% on sugar imports. Calculate the new price of sugar in Tasmania's domestic market. How much will they import after the tariff?
e) Now suppose the government of Tasmania decides to impose a quota of 30 units on sugar imports. Calculate the 'quota equivalent' tariff rate which would have the same effect on the amount of sugar imports.
f) Calculate the change in social welfare in parts d and e above (assume the license holders of the quota are citizens of Tasmania). Decompose the effects on welfare of both tariff and quota into consumer surplus, producer surplus and government revenues. Determine who gains and who loses from the tariff and from the quota.


Solution Preview

a) Let Qs = Qd
P = 100 - P
2P = 100
P = $50

b) With free trade, Tasmania will import sugar because it can buy sugar more cheaply abroad.

c) At the world price of $20, the quantity of sugar demanded in Tasmania is (Qd = 100 - 20 =) 80. The quantity of sugar supplied in Tanzania is (Qs = P =) 20. The quantity imported is the difference: (80 - 20 ...

Solution Summary

This solution shows how to calculate the effects on Tasmania's economy of opening its sugar market to foreign trade. The solution includes a section breaking down the effect of tariffs and quotas on Tasmania's social welfare.