Tuesday, September 16, 2014

Government Intervention 5 - World Price/ Tariffs FRQ's

Government Intervention - World Price/Tariffs

What exactly do I mean when I write (World Price) as a heading for a government intervention post. 

Since a picture or graph is worth a thousand words:

2004 AP Microeconomics Exam - FRQ,  Question 2

These type of FRQ's (Free Response Questions) tend to have a predictive pattern of questioning.

The graph above shows the demand for oil by US residents, the supply of oil by US producers, and the world price of oil. Use the labeling of the graph to answer the following questions:

(A) Identify the following before trade occurs.
  • Price of oil in the US market
  • Quantity of oil produced in the US
Simple right! The price and quantity before trade occurs is the demand and supply curve at equilibrium. Start at (G) and follow the dotted line to P(2) which is equilibrium price, and then follow the dotted line down from (G) to the equilibrium quantity or Q(2).
  • Price of oil in the US market - P(2)
  • Quantity of oil produced in the US - Q(2)
(B) Now assume the US begins to import oil at the world market price of Pw. 
      Identify the quantity imported by the US.

At the world market price (low price) the US quantity demand for oil will be at point H, or Q3.
At the world market price (low price) domestic suppliers will only supply up to point J and the quantity domestically supplied is from 0 to Q1.

So the quantity imported is the total amount (internationally) supplied minus the amount domestically supplied. Since we know that the domestically supplied amount is from 0 to Q1 and the total amount supplied is Q3, then the difference is Q3 minus Q1 (Q3-Q1).

(C) Identify the consumer surplus in the US market for each of the following cases.

  • Before international trade.
  • After international trade.
Before international trade is easy, right? Consumer surplus is simply (K,G,P2),, that triangle is the consumer surplus before world market price is considered.

After international trade is fairly easy also. Consumer surplus after trade is (K,H, Pw).
Mind blown,, did you miss it?

With the lowering of the price the Consumer surplus expands to include what is blow the demand curve and above the world price.

(D) Identify the producer surplus in the US market for each of the following cases.
  • Before international trade
  • After international trade
Before international trade, easy right? Producer surplus is simply (P2,G,P1)
After international trade, (Pw,J,P1).

(E) Identify the net gain in total surplus from trade.

Net gain would be the area under the curve that we didn't have before world price was introduced.

Net gain in total surplus is the area that has been gained by having a world price. The addition of a world price increased consumer surplus and reduced producer surplus, but the only new area under the curve is (J,G,H), the triangle represents the net gain in total surplus.

2012 AP Microeconomics Exam, FRQ, question 3

(a) at the world price of $2 per pound, how much sugar is Loriland importing?

at the $2 world price, domestic suppliers of sugar will only supply 2 million pounds (found where the Pw crosses the domestic Supply curve).

the total amount of sugar supplied is 14 million pounds of sugar, (found where the Pw crosses the Domestic Demand curve), at the low price 14 million pounds is demanded.

So, if 14 million pounds is demanded total,,, and 2 million pounds is supplied domestically, Loriland must be importing 12 million pounds of sugar. (14 - 2 = 12)

(b) Suppose that Loriland imposes a per-unit tariff on sugar imports and the new      domestic price including tariff is $4.

  • identify the new level of domestic production
  • Calculate the domestic consumer surplus for Loriland. (show work)
  • Calculate the total tariff revenue collected by the government. (show work)
to identify the new level of domestic production (be careful, the directions are that the new domestic price is $4 not that the tariff is $4)
So to identify the new level of domestic production travel up the price axis until $4 is reached and then travel across until reaching the domestic supply curve. At a price of $4 the domestic supply is 6 million pounds of sugar.

Calculate the domestic consumer surplus for Loriland. (Remember that the area of a triangle is 1/2 (b x h)

So the consumer surplus at a price of $4 is found by following the dotted line across from the $4 price axis to the demand curve. Where it intersects the demand curve, we travel straight down and find a quantity of 10 million pounds.

On the price axis, from $4 to $9 is 5 (lets call it the height) 
From the $4 price straight across to the demand curve, and then down is 10 (lets call it the base)
-Domestic consumer surplus,, is the area of the consumer surplus triangle-
so, 1/2 (5x10) = 25.. (25 is the consumer surplus)

  • Calculate the total tariff revenue collected by the government. (show work)

  1. understand that if world price was $2 and the price after tariff was $4, then the tariff is $2pds.
  2. the new domestic demand after the tariff, that raises the price up to $4 is for 6 million pds.
  3. at a $4 price 10 million pds is demanded.
  4. 10 million pds minus the 6 million pds produced domestically = 4 million pds imported
  5. 4 million pds times the $2 tariff = $8 million
  6. the total tariff revenue is $8 million pds.

(C) Given the world price of $2, what per unit tariff maximizes the sum of Loriland's domestic consumer and producer surplus?

(Bit of a trick question) - as the per unit tariff that maximizes consumer and producer surplus is ($0 tariff,, nada, zip, no tariff at all)

2004 B AP Microeconomics Exam, FRQ question 3

(A) If the current world price of good X is Pw, does Palconia exports or import good X. Explain.

Placonia, produces locally 50 units of good X but imports units from J to N.
or, they can get unit JN cheaper on the world market, they import mostly.
(The opportunity cost of producing it locally is higher than the world price, so they import.)

(B) Given your answer in part (a), indicate the quantity of good X that Placonia exports or imports.

Placonia, imports 350(N) minus 50(J) = (300 units)

(C) A tariff on good X, increasing the price from Pw to Pt. Indicate the change in each of the following.

  • Consumer Surplus from H,N,Pw to H,M,Pt
  • Producer Surplus from (that itty bitty triangle above supply and below PwJ) to Pt,K,J,Pw
(D) Indicate how employment in the domestic industry that produces good X is affected by the tariff.

Employment in the domestic market will increase.

But why??

If you are supplying dolls to the market and then someone opens a shop across the street and is selling a like good cheaper, you will of course loose business. So you go to your local government and get them to tax(tariff) the dolls of your competitor. That way, you don't really have to compete in the capitalistic sense, you can get the government to protect your profits. The consumer looses by having to pay more for the dolls. You win, not by being smarter, or more efficient, or innovative. You have won simply by the pull of your political connections. Thousands, perhaps millions of consumers have to pay more for the dolls but your profits have increased and the demand for your dolls has increased to the point that you have to hire more workers. 

The argument tends to always be the same:

yes, these reasons are all simplified.
  • Jobs, more domestic jobs (yet, what is not thought about is the cost of those jobs to the consumers of X country) it's argued that steel jobs in America cost the country (taxpayers) upwards of $800,000 per job.
  • Security - if we don't provide it then we really on others and in a time of war, etc they might not sell it to us. Yet, there are thousands of types of goods that we would need to protect to have security for a war. They aren't protected.
  • New industry  - the new industry needs to be protected until they get on their feet. (steel) really?
There are a few more but I'm looking for a discussion.
Please go to Econowaugh's facebook page. 

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