A car production is a constant cost industry (i.e., supply curve is perfectly el

Question

A car production is a constant cost industry (i.e., supply curve is perfectly elastic). Japan can produce cars for $12,000 each; the US can produce them for $16,000; and Mexico can produce them for $20,000 each. Mexican consumers will buy 1 million cars per year if the price is $20,000. Every $1,000 drop in the price generates additional purchases of 100,000 cars. Before the free trade agreement, Mexico had a tarrif on cars equal to $10,000 per car. Mexico signs a FTA with the US, but keeps tariffs for Japan. What is the change in Mexico's economic welfare?

Please explain your steps. Thanks!

A car production is a constant cost industry (i.e., supply curve is perfectly elastic). Japan can produce cars for $12,000 each; the US can produce them for $16,000; and Mexico can produce them for $20,000 each. Mexican consumers will buy 1 million cars per year if the price is $20,000. Every $1,000 drop in the price generates additional purchases of 100,000 cars. Before the free trade agreement, Mexico had a tarrif on cars equal to $10,000 per car. Mexico signs a FTA with the US, but keeps tariffs for Japan. What is the change in Mexico's economic welfare?

Please explain your steps. Thanks!

Explanation / Answer

Mexico economic welfare will increase with this. As this will lower the car price in Mexico. Thus raising consumer surplus and the total surplus. Price will drop to $16000 and there will be 4*100000 =400000 more cars bought in the Mexico.

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