Economics Worksheet With Answers - 2011 (Page 2 of 6) in pdf

Economics Worksheet With Answers - 2011 Page 2

2. In the small country of Freedonia, the domestic demand for widgets is represented by P = 100 –

3Q; the home supply of widgets is represented by P = 1Q.

a. In the absence of trade, what is the equilibrium price and quantity in Freedonia's widget

market?

In the absence of trade, the equilibrium is when supply equals demand. Then demand would

be Q = (100 – P)/3 and supply would be Q = P. Equating gives (100 – P)/3 = P, and solving

for P gives, P = 25. We know that for supply, Q = P, so the equilibrium price = 25 and the

equilibrium quantity = 25.

b. Now suppose Freedonia engages in international trade in widgets. The world price is $40.

How many widgets will be consumed domestically and how many will be exported?

Supply will be determined by P = 1Q, so the total supply is 40. Domestic demand is Q =

(100 – P)/3, so substituting P = 40 gives domestic demand of 20. With total supply of 40 and

domestic demand of 20, exports will be the difference, exports will be 20.

c. Now let the government of Freedonia give a $15 per unit subsidy on each widget exported.

What will be the new price and quantity consumed in the Freedonia domestic market?

Adding $15 to the world price of $40 makes the new domestic price $55. Substituting

P = $55 into Q = (100 – P)/3, gives the new domestic quantity of 15.

d. Calculate the value of the deadweight losses with the $15 per unit export subsidy.

From part (b), consumption falls by 5 units and the subsidy is $15, so this part of the

deadweight loss is ½(5)(15) = 37.50, a reduction in consumer surplus. On the producer side,

the production increases from 40 units to 55 units, an increase of 15 units times the $15

subsidy, so the production loss is ½(15)(15) = 112.50, so the deadweight loss is the sum of

the consumption loss and the production loss, 37.50 + 112.50 = $150.

e. What is the value of total subsidy payments to Freedonia's widget exporters?

With supply of 55 units and domestic consumption of 15 units, exports are 40 units with a

subsidy of $15 each, for a total subsidy payment of $600.

f. Is the subsidy paid to Freedonias's widget exporters considered part of the deadweight losses

of the subsidy?

No, the subsidy is a redistribution of income within the Freedonian economy.

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Economics Worksheet With Answers - 2011 Page 2