Assume that the functions of a demand curve and of a supply curve of a small country M for commodity X are Dx = 130 – Px and Sx = -10 + Px respectively. The unit price of commodity X imported from the rest of the world is 10 USD in the condition of the free trade. Draw the graph and calculate the increase of the producer’s surplus, the decrease of the consumer’s surplus, and the government revenue if the country M would impose the import tariff at the rate of 20% on the commodity X imported from the rest of the world?

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Assume that the functions of a demand curve and of a supply curve of a small country M for commodity X are Dx = 130 – Px and Sx = -10 + Px respectively. The unit price of commodity X imported from the rest of the world is 10 USD in the condition of the free trade. Draw the graph and calculate the increase of the producer’s surplus, the decrease of the consumer’s surplus, and the government revenue if the country M would impose the import tariff at the rate of 20% on the commodity X imported from the rest of the world?

EXPERT ANSWER

Demand : D = 130 – P

Supply : S = -10 + P

At equilibrium,

Demand = Supply

=> 130 – P = -10 + P

=> P + P = 130 + 10

=> 2P = 140

=> P = 140/2

=> P = 70

Equilibrium price, P = 70

Equilibrium quantity, Q = -10 + 70 = 60

At Price = 10,

Demand,D = 130 – 10 = 120

Supply, S = -10 + 10 = 0

Imports = D – S = 120 – 0 = 120

Tariff = 20% of Imports = 0.20 * 120 = 24

New Price = 10 + tariff = 10 + 24 = 34

At New Price = 34,

Demand,D = 130 – 34 = 96

Supply, S = -10 + 34 = 24

New Imports = 96 – 24 = 72

Increase in Producer surplus = (1/2)*(34 – 10)*24 = 288

Decrease in Consumer Surplus = (1/2)*(130 – 10)*120 – (1/2)*(130 – 34)*96 = 7200 – 4608 = 2592

Government Revenue due to tariff = New Imports * Tariff = 72*24 = 1728

Red line is the demand curve and blue line is the supply curve.

The horizontal green line represents price = 10

And, horizontal black line represents price + tariff = 34