Suppose that the domestic demand and supply for hats in a small open economy are given by:
Q = 120 - P (demand)
Q = -60 + 3P (supply)
where Q denotes quantity and P denotes price. (HINT: when graphing these equations, you may want to solve the equations above for P since price is the variable on the vertical axis)
a. What are the autarky price and quantity of hats produced? Show all your calculations.
b. Assume the world price of hats is $30. If this country opens its market to free trade, what are the quantity supplied, the quantity demanded and the quantity of imports? Show all your calculations.
c. Suppose that the country imposes a quota of 10 units. Find the new price after the quota is imposed. Compare the new price (with the quota) to the free trade price. By how much does the price rise after trade is restricted by the quota? What are the quantity supplied, quantity demanded and amount imported with the quota? Show all of your calculations.
d. Graph the Supply and Demand curves below. Be sure to label everything including the axes, the autarky price and quantity, and the intercepts for both the price and quantity axes. Then show the world price and the quantity supplied, quantity demanded and amount of imports you found in part b. Then add the quota from part c. Label the price with the quota you found in part c. Also be sure to label quantity supplied, quantity demanded and the amount imported (the quota) from part c.
e. After the quota in part c is imposed, how has domestic welfare been affected? (Assume all quota rents go to domestic producers and calculate a value for the change in TOTAL welfare between the free trade outcome and the quota outcome.) Show all your calculations.
f. Suppose instead of the quota described in part c that this country negotiates a VER of 10 units with its chief foreign supplier. What are the welfare effects of this policy? (Calculate a value for the change in TOTAL welfare between the free trade outcome and the VER outcome). Show your calculations.