The domestic demand for boomerangs in Australia is given by

The domestic demand for boomerangs in Australia is given by: Q = 5,000 - 100P, where price is measured in dollars and quantity is measured in thousands of boomerangs per year. The domestic supply curve for boomerangs is given by: Q = 150P. What is the domestic equilibrium in the boomerang market? Suppose boomerangs can be imported at a world price of $10 per radio. If trade were unencumbered, what would the new market equilibrium be? How many boomerangs would be imported? If domestic boomerang producers succeeded in having a $5 tariff implemented, how would this change the market equilibrium? How much would be collected in tariff revenues? How much consumer surplus would be transferred to domestic producers? What would the deadweight loss from the tariff be? How would your results from part (c) be changed if the government reached an agreement with foreign suppliers to \"voluntarily\" limit the boomerangs they export to 1,250,000 per year? Explain how this differs from the case of a tariff.

Solution

(a) In domestic equilibrium, Demand = Supply

5,000 - 100P = 150P

250P = 5,000

P = 5,000 / 250 = 20

Q = 150P = 150 x 20 = 3,000

(b)

In absence of trade barriers, world price = Domestic price = $10

When P = $10, Domestic demand = 5,000 - 100P = 5,000 - (100 x 10) = 5,000 - 1,000 = 4,000

Domestic supply = 150P = 150 x 10 = 1,500

Import = Domestic demand - Domestic supply = 4,000 - 1,500 = 2,500

[Consumer surplus (CS) = Area between price and demand curve = (1/2) x $(50** - 10) x 4,000 = (1/2) x $40 x 4,000 = $80,000

** Demand curve is: Q = 5,000 - 100P. When Q = 0, P = 5,000 / 100 = 50 [Vertical intercept of demand curve]

(c)

If $5 of tariff is imposed, domestic price increases by $5.

Domestic price = World price + 5 = 10 + 5 = 15

When P = 15, Domestic demand = 5,000 - (100 x 15) = 5,000 - 1,500 = 3,500

Domestic supply = 150 x 15 = 2,250

Import = Domestic demand - Domestic supply = 3,500 - 2,250 = 1,250

Tariff revenue = $5 x 1,250 = $6,250

Consumer surplus = Area between price & demand curve = (1.2) x $(50 - 15) x 3,500 = (1/2) x $35 x 3,500 = 61,250

Transfer of consumer surplus to producers = $(80,000 - 61,250) = $18,750

Deadweight loss = (1/2) x Change in price x Change in quantity (Imports)

= (1/2) x $(15 - 10) x (2,500 - 1,250) = (1/2) x $5 x 1,250 = $3,125

(d)

A voluntary export restraint (VER) has exactly the same effect on price, domestic demand, domestic supply and amount of imports. Therefore, answer to part (c) will remain the same, except that no tariff revenue can be collected by government. That is what differentiates a VER from a tariff: in case of tariff, government gains in terms of tariff revenue but in case of VER, government\'s revenue is zero.