Tutorial 5

SOLUTIONS TO REVIEW
QUESTIONS

Week beginning ECON10004 Introductory

August 22, 2016 Microeconomics
1. a)

7 Consumer Surplus

1 Demand

1 2 3 4 Q

b) At a price of $4 per bottle, Bert buys 2 bottles. With this price-quantity combination,
Bert receives consumer surplus of $4 (which is equal to ($7-$4)+($5-$4)).

2. a)

7
6

5
4

Producer surplus 2

1 2 3 4 Q
b) At a price of $4 per bottle, Ernie supplies 2 bottles. With this price-quantity
combination, Ernie receives producer surplus of $4 (which is equal to ($4-$1)+($4-$3).

3. a) Equilibrium price and quantity traded in the absence of any restriction in the
market are derived by equating demand and supply (2000 2P = 3P), which yields
P* = 400, and Q* = 1200.

b) With a restriction to Q = 1000, less than the equilibrium quantity Q*=1200, the price
will be determined by demand. From the demand equation, where Q = 1000, it must
follow that P = 500.

quota
Supply
1000
A
500
B
D
400
E
C
333.33
Demand

1000 1200 2000 Q

No quota With quota Change

Consumer surplus A+B+D A -B-D
Producer surplus C+E B+C +B-E
Total A+B+C+D+E A+B+C -D-E

Consumers are made unambiguously by the introduction of a quota (lower quantity

traded and higher price). Producers benefit from the higher price but lose from the
lower quantity; overall, however, it is possible to calculate that the gain equal to area B
is 100 x 1000 = 100,000 against a loss equal to area E which is (200 x 66 2/3)/2 = 6,666
2/3 so that there is a net increase in producer surplus. Total surplus is reduced by the
amount of D+E, which is therefore the deadweight loss from introduction of the quota.
4. a) Without international trade, we have:

P
SAUS

CS

P*

PS

DAUS

Q*

b) With trade:

exports
World price
A
D
B C
P*
F

QD QS
Q*

c)

No international International trade Change

trade
CS A+B+C A -(B+C)
PS E+F B+C+D+E+F +B+C+D
Total surplus A+B+C+E+F A+B+C+D+E+F +D
With international trade (exports), Australian consumers are made worse off and
Australian suppliers are made better off. Overall there is an improvement in well-being.
5. An import quota is a maximum amount of imports that the government specifies are
allowed to be consumed.

a) The effect of a quota on imports of clothing from China to Argentina would be to:
Pquota
(i) Increase the price of clothing in Argentina from the world price to equal . In the
absence of a restriction on international trade then the world price is the highest price
any consumer would be willing to pay. But with the import quota, then it is necessary
for consumers to purchase from some Argentine suppliers who have higher opportunity
cost of supply than the world price.
(ii) Increase quantity of clothing supplied by Argentine suppliers. This is because of the
increase in price received by suppliers.
(iii) Decrease the quantity of imports to the amount specified by the import quota.
Consumers would like to purchase more than this amount of imports (since it would
allow them to pay the world price), but cannot do so because of the import quota.

Price
SArgentina

SArgentina +
import quota

B
Pquota

C E
D F G
World price
H
DArgentina

Q1S Q2S Q2D Q1D Qty clothing

Import quota

Figure 1
b) The import quota will cause an increase in the welfare of producers and decrease in
welfare of consumers:

No import quota With import quota Change

Consumer surplus A+B+C+D+E+F+G A+B -C-D-E-F-G
Producer surplus H C+H +C
Importer E+F +E+F
Total surplus A+B+C+D A+B+C+E+F+H -D-G
+E+F+G+H

Consumers in Argentina are made worse off because they consume a smaller quantity
and must pay a higher price. Producers in Argentina are made better off because they
sell a larger quantity at a higher price.

[Importers are better off because they will receive the price P quota which is above the
world price that they would receive without the import quota. Often, having introduced
an import quota, and knowing that importers will then earn an extra premium from
selling imports, governments will make importers pay for the right to bring imports into
a country. In the case above, the government could charge up to an amount equal to
(Pquota minus the world price), and importers would still be willing to import.]

[The effect of the import quota is to reduce total surplus. That is, the regions D and G
represent deadweight loss. Area D represents inefficient production by Argentine
producers. That is, Argentine producers, who have an opportunity cost greater than the
world price (and hence are wasting resources relative to buying at the world price from
Q1s to Q s2
China), supply the units from when the import quota is introduced. Area G
represents inefficient consumption by Argentine consumers. That is, the increase in the
price due to the import quota causes consumers who have valuations between the world
Q 2D minus Q1D
price and Pquota to stop consuming (an amount equal to ) whereas these
consumers could have consumed and gained a positive net benefit from consumption if
they were allowed to purchase at the world price.]