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?

$6.6 billion

$4.8 billion

$4.0 billion

$3.2 billion

$6.6 billion

$4.8 billion

$4.0 billion

$3.2 billion

Explanation / Answer

Change in Total surplus = Change in consumer surplus+Change in producer surplus.

With FTA with US there will 400000 more cars sold this increase consumer surplus by 400000*16000 = 6.4 billion

While producer will lose = 400000*4000=$1.6 billion.

Change in total surplus = 6.4 - 1.6 =4.8 billion

So, option b

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