Costa Rica is a “small” country and assumed to be unable to affect world prices.
ID: 1201938 • Letter: C
Question
Costa Rica is a “small” country and assumed to be unable to affect world prices. It imports blueberries at the price of 10 dollars per box.
The Domestic Supply and Domestic Demand curves for boxes are: S = 60 + 20P D = 1160 15P
a) Assume Costa Rica is completely open to trade. What is the equilibrium price and quantity consumed? How much is produced domestically, and how much is imported?
b) Now consider the effect of an import quota of 400 boxes. What happens to the price of Blueberries and quantity consumed?
c) Who wins and who loses? Discuss consumers, domestic producers, and importers (Be sure to compute the change in their welfare).
Explanation / Answer
(a) For a small country, in presence of free trade, relevant price is the world price of imported good. So, P = $10
When P = 10, domestic consumption (Qd) = 1160 - 15P = 1160 - (15 x 10) = 1160 - 150 = 1010
Domestic production (Qs) = 60 + 20P = 60 + (20 x 10) = 60 + 200 = 260
Imports = Qd - Qs = 1010 - 260 = 750
Consumer surplus (CS) = Area between demand curve & price
From demand function, when Q = 0, P = 1160 / 15 = 77.33 (Reservation price)
CS = (1/2) x $(77.33 - 10) x 1010 = (1/2) x $67.33 x 1010 = $34,002
Producer surplus (PS) = Area between supply curve & price
= (1/2) x $10 x 260 = $1,300
Total imports = $10 x 750 = $7,500
(b) Import quota = 400 means, Qd - Qs = 150
1160 - 15P - 60 - 20P = 400
1100 - 35P = 400
35P = 700
P = 20 (Price rises)
When P = 20, Qd = 1160 - (15 x 20) = 1160 - 300 = 860 (Fall in quantity demanded)
Qs = 60 + (20 x 20) = 60 + 400 = 460
(c) With the quota,
CS = (1/2) x $(77.33 - 20) x 860 = (1/2) x $57.33 x 860 = $24,652
So, CS has decreased by $(34,002 - 24,652) = $9,350 and consumers are worse off.
PS = (1/2) x $20 x 460 = $4,600
PS has increased by $(4,600 - 1,300) = $3,300 and producers are better off.
Total imports = $20 x 400 = $8,000
Importers are better off by $(8,000 - 7,500) = $500.