2. In autarky, the domestic economy has a single producer of aluminum. Without t

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2. In autarky, the domestic economy has a single producer of aluminum. Without trade this firm can and does operate like a monopoly. Its operating conditions can be completely described by its total cost function TC(Q)-450+10*Q+0.0625 Q and the domestic demand for aluminum which is given by the (inverse) demand function P(O) -60-0.25*Q. Here the Q represents pounds of aluminum and P represents pesos per pound. a Graph the marginal [MC(Q)] and average total cost [ATC(O)] functions for this firm along with the demand curve and marginal revenue [MR(Q)] function. Derive (using calculus, not the graph) the monopolists optimal output and price if the firm maximizes profits in autarky. Indicate both on your graph. What is the total profit available to the firm in autarky? If this country begins to trade with the rest of the world, this aluminum producer will no longer be a monopolist. Indeed, the domestic economy is so small relative to the rest of the world, that it can buy or sell as much aluminum as it wants when trading with the rest of the world at the current world price Pw-15. Under these conditions, how much aluminum will domestic consumers buy? How much will this domestic producer make in the short run? How much aluminum will be imported? Will this monopolist continue to produce in the long run? Explain. b) c) If instead of free trade, the aluminum producer lobbies, successfully, for a tariff of 10 pesos on each pound of imported aluminum the domestic price Ps-Pw+10. Under this trade restriction, calculate domestic production, consumption and imports. How much tariff revenue would the government collect? Is restricted trade (with this tariff) preferred to free trade for either the producer or consumers? Is restricted trade (with this tariff) preferred to autarky for either the producer or consumers? If instead of a tariff, the aluminum producer lobbies, successfully for an import quota that allows imports of exactly 20 pounds of aluminum, what will be produced, consumed and imported by the domestic economy? What is the maximum revenue d) the government could extract by auctioning off the right to import those 20 pounds under a quota? the firm prefer the quota or the tariff? Is aggregate welfare higher with free trade, trade with the proposed tariff, trade with an import quota of 20 pounds or autarky? Do consumers prefer the tariff (above) or the import quota? Does e) Please explain how you are able to rank these alternatives.

Explanation / Answer

E) Agrgregate welfare will be higher with free trade. import quota will restrict supply of aluminum in the domestic market. This will result in increase demand and subsequently will induce an increase in the price of aluminum. The higher price will in turn reduce demand and increase domestic supply causing a reduction in import demand. Quotas tend to cause a bigger fall in economic welfare because the government don't gain any tax revenue that they get with tariffs. Producers gain as a result of tariffs while consumers are worse off. Government receives tariff revenue as a result of tariff. On the aggregate a tariff reduces national welfare

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