Suppose a Canadian lumber company has a world monopoly on lumber. That is, imagine that all lumber purchased by U.S. citizens is bought from this one Canadian lumber company. The inverse demand curve for U.S. consumers (note that “consumers” means any person or business that wants lumber, so construction firms are included) is p(Q) = 8− 1 2Q, and the lumber company has a constant marginal cost of 2.
a. Assume there is no government intervention, the Canadian lumber company must charge a uniform price to all U.S. consumers, and there is no resale between countries. In other words, the lumber company charges a price p and U.S. consumers can either purchase lumber at p or not purchase lumber at all. What will be the equilibrium quantity, price, and consumer surplus?
b. Suppose the U.S. government imposes a price ceiling. What is the optimal price ceiling from the U.S. government’s perspective, i.e. the one that maximizes U.S. consumer surplus? What is this consumer surplus?
c. Suppose instead that the U.S. government imposes a tariff of t dollars per unit, where 0 ≤ t ≤ 6. Draw a supply-demand graph and label consumer surplus and government revenue. Use the graph to show that the tariff cannot possibly yield as much total surplus as the price ceiling.
d. Why might these policies not increase total surplus as much as we are predicting? (Hint: How might Canada respond?)