Global Econ

Table illustrates the demand and supply schedules for television sets in Venezuela, a “small” nation that is unable to affect world prices. On graph paper, sketch Venezuela’s demand and supply schedules of television sets.

a. Suppose Venezuela imports TV sets at a price of $150 each. Under free trade, how many sets does Venezuela produce, consume, and import? Determine Venezuela’s consumer surplus and producer surplus.

b. Assume that Venezuela imposes a quota that limits imports to 300 TV sets. Determine the quota-induced price increase and the resulting decrease in consumer surplus. Calculate the quota’s redistributive, consumption, protective, and revenue effects. Assuming that Venezuelan import companies organize as buyers and bargain favorably with competitive foreign exporters, what is the overall welfare loss to Venezuela as a result of the quota? Suppose that foreign exporters organize as a monopoly seller. What is the overall welfare loss to Venezuela as a result of the quota?

c. Suppose that, instead of a quota, Venezuela grants its import-competing producers a subsidy of $100 per TV set. In your diagram, draw the subsidy-adjusted supply schedule for Venezuelan producers. Does the subsidy result in a rise in the price of TV sets above the free-trade level? Determine Venezuela’s production, consumption, and imports of TV sets under the subsidy. What is the total cost of the subsidy to the Venezuelan government? Of this amount, how much is transferred to Venezuelan producers in the form of a producer surplus, and how much is absorbed by higher production costs due to inefficient domestic production? Determine the overall welfare loss to Venezuela under the subsidy.

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SOLUTION:

a. Qs = 100, Qd = 800

Imports = 700.

Consumer surplus = $160,000

Producer surplus = $2500.

b. Price rises by $100 and consumer surplus falls by $70,000.

Redistribution effect = $20,000

Consumption effect = $10,000

Protective effect = $10,000

Revenue effect = $30,000.

Overall welfare loss = $50,000.

c. Price remains at the free trade level.

Qs = 300,

Qd = 800,

Imports = 500.

Total cost of subsidy = $30,000 of which $20,000 is absorbed by producer surplus and $10,000 is absorbed by higher domestic production costs.

Overall welfare loss = $10,000.