tariff raises domestic price. The monopolist, still facing a perfectly elastic demand curve, sets output such that marginal cost equals internal price. A monopolist faces a downward sloping demand curve under a quota. A quota is not equivalent to a tariff in this case. Domestic production is lower and internal price higher when a particular level of imports is obtained through the imposition of a quota rather than a tariff.
ANSWERS TO TEXTBOOK PROBLEMS
1. The import demand equation, MD, is found by subtracting the home supply equation from
the home demand equation. This results in MD = 80 - 40 x P. Without trade, domestic prices and quantities adjust such that import demand is zero. Thus, the price in the absence of trade is 2.
2. a. Foreign's export supply curve, XS, is XS = -40 + 40 x P. In the absence of trade, the price
is 1.
b. When trade occurs export supply is equal to import demand, XS = MD. Thus, using the
equations from problems 1 and 2a, P = 1.50, and the volume of trade is 20.
3. a. The new MD curve is 80 - 40 x (P+t) where t is the specific tariff rate, equal to 0.5. (Note:
in solving these problems you should be careful about whether a specific tariff or ad valorem tariff is imposed. With an ad valorem tariff, the MD equation would be expressed as MD=80-40 x(1+t)P). The equation for the export supply curve by the foreign country is unchanged. Solving, we find that the world price is $1.25, and thus the internal price at home is $1.75. The volume of trade has been reduced to 10, and the total demand for wheat at home has fallen to 65 (from the free trade level of 70). The total demand for wheat in Foreign has gone up from 50 to 55.
b. and c. The welfare of the home country is best studied using the combined numerical and
graphical solutions presented below in Figure 8-1.
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