COURSE: Marketing & Sales in New Manufacturing (Individual Exercise 3)

LECTURER: Prof. Christina RAVENS

STUDENT NAME: Roselyn Boniface EJEIKWU

STUDENT NUMBER: 3005895

p. 267, Question 1-4 (Chapter 9)

1. Home's demand curve for books is D= 50- 10P. Its supply curve is S = 10 + 10P. Derive
and graph Home's import demand schedule. What would the price of books be in the
absence of trade?

SOLUTION:

The demand curve is D = 50 – 10P and the supply curve is S = 10 + 10P.

Setting (D = S):

50 - 10P = 10 + 10P

Solving for (P):

40 = 20P

P=2

In this Graph:

D represents the domestic demand curve: D = 50 - 10P.

S represents the domestic supply curve: S = 10 + 10P.

M represents the import demand schedule: M = 40 - 20P.

The equilibrium points where D intersects S is at P = $2 and Q = 30.

The import demand schedule M starts from (0, $40) on the price axis, and its slope is twice
as steep as the demand curve.

At the equilibrium price of $2, the quantity demanded and supplied domestically is 30
units, as indicated by the intersection of D and S.
Price (P

50 - |------------------ D = 50 - 10P

| /\

| / \

| / \

| / \

| / \

40 - | / M = 40 - 20P

|/

30 - |------------------ S = 10 + 10P

|__________________________

Q = Quantity of Books

2. Now add Foreign, which has a demand curve D= 60 – 10P and a supply curve S = 20 +
10P.

a. Derive and graph Foreign's export supply curve and find the price of books that would
prevail in Foreign in the absence of trade.

SOLUTION:

Demand curve: ( D = 60 - 10P )

Supply curve: ( S = 20 + 10P )

The export supply curve ( XS ) represents the amount of goods Foreign producers are
willing to export at different prices. It is calculated as the excess of what Foreign producers
supply over what Foreign consumers demand.

Step-by-Step Derivation
Set the Demand and Supply Equations Equal to Find Equilibrium Price Without Trade:
D=S
60 - 10P = 20 + 10P
Solving for ( P ): 60 - 20 = 20P
40 = 20P
P=2

Find Equilibrium Quantity Without Trade: Substitute ( P = 2 ) into either the demand or
supply equation:
S = 20 + 10 \times 2 = 20 + 20 = 40
So, the equilibrium quantity is ( Q = 40 ).

Thus, the price of books in Foreign in the absence of trade is P = 2

Derive the Export Supply Curve:

The export supply at a given price ( P ) is: XS = S - D
Using ( S= 20 + 10P ) and ( D= 60 - 10P ):
XS = (20 + 10P) - (60 - 10P) = 20 + 10P - 60 + 10P = 20P - 40
Therefore:
XS = 20P – 40

Price (P)

| |\

| | \

3| | \

| | \

| | \

2|--------|------\---------------- XS = 20P - 40

| | \

| | \

1| | \

| | \

|___________________________

Q = Quantity of Books
In this graph:

The export supply curve (XS = 20P - 40) starts from (P = 2, Q = 0) and extends upwards with
a slope of 20.

At P = 2, the export supply curve intersects the price axis, indicating that at this price, there
are no excess books available for export.As the price increases, the quantity of books
available for export increases, as shown by the upward slope of the curve.

b. Now allow Foreign and Home to trade with each other, at zero transportation cost. Find
and graph the equilibrium under free trade. What is the world price? What is the volume of
trade?

SOLUTION:

Home's import demand curve is derived from ( D - S ), and Foreign's export supply curve
from (S - D). Using their respective supply and demand functions:

Home: ( D = 50 - 10P ) and ( S = 10 + 10P )

Foreign: ( D = 60 - 10P ) and ( S = 20 + 10P )

Set Home demand minus supply equal to Foreign supply minus demand:
[ (50 - 20) - (10 + 10P - 20 - 10P) = (20 + 10P - 10 - 10P) ]

Solving for ( P ), we find the world price ( P_w = 2 ).

At this price, find quantities for volume of trade:

[ Q_{trade} = D_{Home} - S_{Home} = (50 - 10(2)) - (10 + 10(2)) = 20 ]

Thus, the world price is 2, and the volume of trade is 20 units

Price (P)

4| .

| |\

| | \

3| | \

| | \

| | \

2|--------|------ \---------------- P_w = 2

| | \

| | \

1| | \

|_______|_________\_____________

Q = Quantity of Books

In this graph:

The world price (P_w = 2) is marked on the vertical axis.

The equilibrium quantity traded (Q_trade = 20 units) is marked on the horizontal axis.

The equilibrium occurs where Home's import demand equals Foreign's export supply.

The volume of trade is represented by the difference between Home's demand and supply
at the world price.

3. Home imposes a specific tariff of 1.5 on books imports.

a. Determine and graph the effects of the tariff on the following: (1) the price of books in
each country; (2) the quantity of books supplied and demanded in each country; (3) the
volume of trade.

SOLUTION:
To accurately draw the graph representing the effects of Home imposing a specific tariff of
$1.5 on book imports, the following steps was implied:

Label the Axes:

Horizontal axis: Quantity of Books (Q)

Vertical axis: Price (P)

Plot the Original Curves:

Home's demand curve: D=50−10P

Home's supply curve: S=10+10P

Foreign's demand curve: D=60−10P

Foreign's supply curve: S=20+10P

Equilibrium price without trade: P=2

Equilibrium quantity without trade: Q=30

Derive and Plot Import Demand and Export Supply:

Home's import demand: MD=40−20P

Foreign's export supply: XS=20P−40

Equilibrium under free trade: Pw =2, Qtrade =20

Effect of Tariff:

New domestic price in Home: Pd =Pw +1.5=3.5

New export price in Foreign: Pe =Pw −1.5=0.5

New Curves with Tariff:nAdjust Home’s import demand to reflect the higher domestic
price.Adjust Foreign’s export supply to reflect the lower export price.

Graph Construction:

Draw the original import demand curve MD=40−20P.

Draw the original export supply curve XS=20P−40.

Mark the original equilibrium point at Pw =2 and Qtrade =20.

Shift the import demand curve leftward to reflect the tariff, which can be represented as a
parallel shift downward due to the increased price.
Mark the new equilibrium point at Pd =3.5 for Home and Pe =0.5 for Foreign.

Indicate the reduced volume of trade.

Price (P)

5|

4|

3 |------------------ Original P_w = 2

|\ New P_d = 3.5

2.5| \

| \

2 |-----\------------- Original MD = 40 - 20P

| \

1.5| \

| \

1 |---------- \---- New P_e = 0.5

| \

|-------------\-------------------- New MD (with tariff)

0 |___________\____________________

20 30 Q (Quantity of Books)

In this graph:
The original equilibrium is at Pw=2Pw =2 with Qtrade=20.

The new equilibrium with the tariff shows the domestic price at Home increasing to Pd =3.5
and the export price in Foreign decreasing to Pe =0.5.

The import demand curve shifts leftward, indicating reduced imports.

The volume of trade decreases, represented by the reduced intersection point on the
quantity axis.

b. Determine the effect of the tariff on the welfare of each of the following

groups: (1) Home import-competing producers; (2) Home consumers; (3) the home
government.

SOLUTION:

Determine the effect of the tariff on the welfare of each of the following groups:

1. Home Import-Competing Producers: Increased Producer Surplus: Due to the imposition

of the tariff, domestic prices rise, which benefits home import-competing producers. As
they receive a higher price for their goods, their producer surplus increases.

2. Home Consumers: Decreased Consumer Surplus: Home consumers face higher prices
for imported goods as a result of the tariff. This results in a reduction of consumer surplus,
thereby making the consumers worse off 1.

3. The Home Government: Increased Government Revenue: The home government

benefits from the tariff by collecting additional revenue. This revenue is calculated as the
tariff rate multiplied by the volume of imports post-tariff, adding to the government’s
financial resources

c. Show graphically and calculate the terms of trade gain, the efficiency loss and the total
effect on welfare of the tarif.

SOLUTION

Terms of Trade Gain: Tariff Revenue=Tariff×Qtrade′Tariff Revenue=Tariff×Qtrade′

Assuming the new quantity of imports, Qtrade′Qtrade′ , is calculated from the new import
demand curve:

At Pd=3.5Pd =3.5:
MD=40−20(3.5)=40−70=−30 (which is impractical, hence trade reduces
significantly)MD=40−20(3.5)=40−70=−30 (which is impractical, hence trade reduces
significantly)

Thus, the tariff revenue is a function of the significant reduction in trade.

Efficiency Loss: The efficiency loss consists of both the consumption distortion loss and
the production distortion loss. These can be calculated as areas of triangles formed by the
shifts in supply and demand due to the tariff.

Total Effect on Welfare: The total effect on welfare is the sum of the terms of trade gain and
the efficiency loss. Since the efficiency loss typically outweighs the terms of trade gain in
the presence of significant trade reductions, we expect a net welfare loss.

Given the abstract representation without specific numerical values, assume:

Tariff Revenue (TR): TR=1.5×Qtrade′TR=1.5×Qtrade′

Efficiency Loss (EL): Approximate through areas formed by triangles in graphical shifts.

Net Welfare Impact (NWI): NWI=TR−ELNWI=TR−EL

Price (P)

5 |

4 |

|\

3 |\ Original MD = 40 - 20P

|\

2.5 | \

2 |-----\--------- Original P_w = 2

| \

1.5 | \

|----------\--- New P_d = 3.5

1 | \

| \

0.5 |--------------\---- New P_e = 0.5

| \

|_________________\_______\_____________________

Q1 Q2 Q (Quantity of Books)

4. Suppose Foreign had been a much smaller country with domestic demand. D= 8 - 2P, S
= 4 + 2P

(Notice that this implies the foreign price of books in the absence of trade would have been
the same as in problem 2).

Recalculate the free trade equilibrium and the effects of a 1.5 specific tariff by Home.
Relate the difference in results to the discussion of the small-country case in the text.

SOLUTION
Step 1: Equilibrium Price in the Absence of Trade

Given:

Foreign Demand Curve: ( D = 8 - 2P )

Foreign Supply Curve: ( S = 4 + 2P )

To find the equilibrium price in Foreign in the absence of trade, set the demand equal to
the supply:
[ 8 - 2P = 4 + 2P ]

Solving for ( P ):
[ 8 - 4 = 4P ]
[ 4 = 4P ]
[P=1]

The equilibrium price in Foreign without trade is ( P = 1 ).

Step 2: Free Trade Equilibrium

For free trade, we combine the import demand curve of Home with the export supply curve
of Foreign.

Home Import Demand Curve

Home's demand and supply curves are given as:

( D = 50 - 10P )

( S = 10 + 10P )

The import demand curve ( MD ) for Home is derived as:

[ MD = D - S ]
[ MD = (50 - 10P) - (10 + 10P) ]
[ MD = 40 - 20P ]

Foreign Export Supply Curve

The export supply curve ( XS ) for Foreign is derived as:

[ XS = S- D]
[ XS = (4 + 2P) - (8 - 2P) ]
[ XS = 4 + 2P - 8 + 2P ]
[ XS = 4P - 4 ]

Equilibrium Calculation
Set the import demand equal to the export supply:
[ 40 - 20P = 4P - 4 ]

Solving for ( P ):
[ 40 + 4 = 24P ]
[ 44 = 24P ]
[ P = \frac{44}{24} ]
[ P = \frac{11}{6} \approx 1.83 ]

The equilibrium price under free trade is approximately ( P = 1.83 ).

Step 3: Effects of a Specific Tariff by Home

Home imposes a specific tariff (t) of 1.5 on the imports.

Impact on Prices

The world price ( P_w ) is now adjusted for the tariff in Home:
[ P_H = P_w + t ]
[ P_H = 1.83 + 1.5 = 3.33 ]

Foreign's price will be:

[ P_F = P_w = 1.83 ]

Quantities Supplied and Demanded

In Home, the new quantity demanded and supplied at price ( P_H = 3.33 ) are:
[ D_H = 50 - 10(3.33) \approx 16.67 ]
[ S_H = 10 + 10(3.33) \approx 43.33 ]
[ MD_H = D_H - S_H \approx 16.67 - 43.33 ]

In Foreign, the new quantity supplied and demanded at price ( P_F = 1.83 ) are:
[ D_F = 8 - 2(1.83) \approx 4.34 ]
[ S_F = 4 + 2(1.83) \approx 7.66 ]
[ XS_F = S_F - D_F \approx 7.66 - 4.34 = 3.32 ]

Volume of Trade

The volume of trade (V) is the minimum of Home’s import demand and Foreign's export
supply:
[ V \approx \min(MD_H, XS_F) = \min(16.67 - 43.33, 3.32) ]

Since actual calculation of ( MD_H ) was approximated incorrectly before, we'll consider
the import demand correctly:
[ MD_H = D_H - S_H = 16.67 - 43.33 \approx -26.66 ]
Discussion on Small-Country Case

When analyzing the impacts of a specific tariff in the context of a small-country case, the
primary distinction is the capacity of the small country to influence the world price. The
results reveal that the imposition of a tariff by Home mainly increases the local price of the
good by the full tariff amount, illustrating Home's incapacity to impact the international
price significantly. This scenario aligns with the typical theoretical expectations for the
small-country model, where the domestic price fully reflects the tariff while the global
price remains unaffected