1. Suppose Home is a small open economy, exporting wheat to the world market. At

Question

1. Suppose Home is a small open economy, exporting wheat to the world market. At the world price of $100 per ton, Home growers export 20 tons. Now suppose the Home government decides to support its domestic producer with an export subsidy of $40 per ton. Use the following figure to answer these questions Home price 140 100 10 20 40 50 Quantity a) What is the quantity exported under free trade and with the export subsidy? b) Using the letters above, what is the effect of the export subsidy on consumer surplus, producer surplus, and government revenue? What is the overall net effect of the export subsidy on Home welfare?

Explanation / Answer

1)

Home produces 40 tons and exports 20 tons with free trade.
Reason:
at $100 per ton, the price intersects the supply curve so home will want to produce 40 tons at that price, however at $100 only 20 tons are demanded domestically. What can home do with the extra 20 tons? it exports them at $100 per ton.

Home produces 50 tons and exports 40 tons with the subsidy
Reason:
at $140 per ton, the price intersects the supply curve at a point where home will want to produce 50. At this price however only 10 tons are demanded domestically. Home ships off the 50 - 10 = 40 tons to another country who buys it at $100 / ton

Consumer surplus under free trade
use the triangle area formula 1/2 b h
we already know that the base is 20 under free trade and 10 under the subsidy so we need to find the y intercept for the demand curve to find height.
slope formula
y2 - y1 / x2 - x1 = 140 - 100 / 10 - 20 = -4 slope
line formula (b is the y intercept and our height)
Y = mX + b = 100 = -4(20) + b
b = 180
now consumer surplus is not the entire area, it is only the area above equilibrium
so we have 180 - 100 = 80 height for free trade and 180 - 140 = 40 for subsidized

area =
1/2 (b) (h)
1/2 (20) (80)
= 800 under free trade

area =
1/2 (b) (h)
1/2 (10) (40)
= 200 under subsidized trade

so its great to be the exporting business with subsidy trade just not so good if you are living domestically in the country and want to buy that good : /

hopefully that was your lifesaver you were looking for ha. peace out   

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