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PROBLEM SET 1
Pugel 12 “Questions and Problems,” pp. 31-32: 1*,2, 3♣, 4, 5♣,
6, 7♣
♣
Answers in back of textbook
ADDITIONAL PROBLEMS
1.
Suppose that the domestic markets for tulips in the nations
of Roseland and Chrysanthemum can be depicted by the demand
and supply diagrams below:
Price of Tulips per Dozen
Roseland's Tulip Market
$35
$30
S
$25
$20
$15
$10
$5
D
$0
0
1
2
3
4
5
6
7
8
9
10 11
Dozens of Tulips (Q)
Chrysanthemum's Tulip Market
Price per Dozen
$30
S
$25
$20
$15
$10
$5
D
$0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Dozens of Tulips (Q)
a.
Assuming that the two countries decide to allow free
international trade in tulips, derive the international demand curve
and supply curve for tulips using the diagram below:
2
INTERNATIONAL TULIP MARKET
Price per Dozen
$20
$15
$10
$5
0
1
2
3
4
5
6
7
8
9
10
11 12
Dozens of Tulips
b.
Which country imports tulips and which country exports
tulips? How many tulips will be traded and what will be the price
of tulips internationally?
3
2.
If free trade is allowed, U.S. lumber companies make 52
billion board-feet of lumber each year, of which 42 billion board-feet
are sold in the United States. The average price is $.30 per boardfoot. If lumber exports are banned by law, production (for the
domestic market only) is 48 billion board-feet, and the price drops to
$.25 per board-foot. This is illustrated in the graph below:
Price ($ per board-foot)
S
Price with
export ban
$.30
a
b
c
$.25
D
42
48
52
Quantity (bil. of boardfeet)
a. Assuming trade is allowed, calculate the amount of exports
and label in the appropriate place on the diagram above.
b. Calculate the loss in producer surplus from the export
ban.
c. Calculate the gain in consumer surplus from the export
ban.
d. Does the U.S. experience a net gain or net loss if it bans
exports of lumber?
4
3.
Consider the graphs of the domestic markets for bread in the
hypothetical countries of Leinster and Saxony:
Price of bread (per loaf)
Price of bread (per loaf)
S
$.60
a
b
c
S
$.25
D
$.25
$.20
d
e
f
D
20
50
LEINSTER
100 Q
10
60
SAXONY
90 Q
a. If there is no trade allowed between the two countries, what
will be the price of a loaf of bread in each country? How much will
domestic residents consume and produce in each country?
b. Suppose that trade is allowed and that the international price
of bread settles at $.25 per loaf. Which country will export bread
and which country will import bread? How can you tell? Calculate
and label the exports and imports in the graphs as appropriate.
c. Consider Leinster: As a result of trade (compared with no
trade), is there a gain or a loss in consumer surplus? Calculate the
dollar-value of the gain or loss in consumer surplus. Is there a gain
or a loss in producer surplus? Calculate the dollar-value of the gain
or loss in producer surplus. Is there a net gain or a net loss as a
result of trade?
d. Consider Saxony: As a result of trade (compared with no
trade), is there a gain or a loss in consumer surplus? Calculate the
dollar-value of the gain or loss in consumer surplus. Is there a gain
or a loss in producer surplus? Calculate the dollar-value of the gain
or loss in producer surplus. Is there a net gain or a net loss as a
result of trade?
5
4.
In the mid-1990’s, the United States imported about 3 billion
barrels of oil per year. Perhaps it would be better for the United
States if it could end the billions of dollars of payments to foreigners
by not importing this oil. After all, the United States can produce its
own oil (or other energy products that substitute for oil). If the United
States stopped all oil imports suddenly, it would be very disruptive.
But perhaps the United States could gain if it gradually restricted and
then ended oil imports in an orderly transition. If we allow time for
adjustments by U.S. consumers and producers of oil, then the
following graph shows domestic demand and supply conditions in the
United States.
PRICE ($)
US OIL MARKET
42
36
30
24
S
18
12
6
0
D
0
1
2
3
4
5
6
7
8
QUANTITY (bil. of barrels per year)
a.
With free trade and an international price of $18 per barrel, how
much oil does the United States produce domestically? How much
does it consume? Indicate on the graph the quantity of U.S.
imports of oil.
b.
If the United States stopped all imports of oil (in a way that
allowed enough time for orderly adjustments), how much oil would be
produced in the United States? How much would be consumed?
What would be the (approximate) price of oil in the United
States? Show all of this on the graph.
c.
If the United States stopped all oil imports, which group(s) in the
United States would gain? Which group(s) would lose? As
appropriate, refer to your graph in your answer.
6
SELECTED ANSWERS
Pugel 12, pp. 31-32 (Answers to odd-numbered problems are in
the back of the textbook):
2.
Producer surplus is the net gain to producers from being able to
sell a product through a market. It is the difference between the
lowest price at which some producer is willing to supply each unit of
the product and the actual market price that is paid, summed over all
units that are produced and sold. The lowest price at which someone
is willing to supply the unit just covers the extra (marginal) cost of
producing that unit. To measure producer surplus for a product using
real world data, three major pieces of information are needed:
i.
The market price.
ii.
The quantity supplied.
iii.
Some information about the slope (or shape) of the
supply curve. That is, how would quantity supplied
change if the market price decreased? Or, what are
the extra costs of producing each unit up to the
actual quantity suppled?
Producer surplus could then be measured as the area below the
market price line.
4.
The country’s demand for imports is the amount by which the
country’s domestic quantity demanded exceeds the country’s domestic
quantity supplied. The demand-for-imports curve is derived by finding
the difference between domestic quantity demanded and domestic
quantity supplied, for each possible market price for which quantity
demanded exceeds quantity supplied. The demand-for-imports curve
shows the quantity that the country would want to import for each
possible international market price.
7
6.
If there were no exports of scrap iron and steel, the domestic
market would clear at the price at which domestic quantity demanded
equals domestic quantity supplied. This is at P1 in the diagram below.
Price
SUS
Exports
(With trade) P2
(No trade)
P1
DUS
Quantity of scrap
iron and steel
But the United States does export scrap iron and steel. The extra
demand from foreign buyers increases the market price of scrap iron
and steel. See P2 in the above diagram. Domestic users (consumers)
of scrap iron and steel pay a higher price than they would if there were
no exports. Thus, some users support a prohibition of these exports,
in order to lower the market price of the scrap that they buy.
8
ADDITIONAL PROBLEMS:
1.
a.
16
S (C's exports)
14
12
Price
10
8
6
D (Roseland's imports)
4
2
0
0
2
7
Exports and Imports
b.
Roseland imports tulips and Chrysanthemum exports
tulips. This is because without trade the equilibrium price of tulips in
Roseland ($15) is higher than that in Chrysanthemum (5). Thus, it
would be profitable to ship tulips from Chrysanthemum to Roseland.
The international price of tulips is $10 and 2 dozen are traded.
9
2.
a.
b.
c.
d.
3.
Exports = 10 billion board feet at international price of
$.30.
Areas a + b + c = ($.05 x 42) + (½ x $.05 x 6) + (½ x 10
x $.05) = $2.1 + $.15 + $.25 = $2.5 billion.
Areas a + b = = $2.1 + $.15 = $2.25 billion.
Net loss because loss of producer surplus > gain in
consumer surplus.
a.
Leinster: P = $.60, consumption and production = 50
loaves.
Saxony: P = $.20, consumption and production = 60
loaves.
b.
Leinster will import bread because, at the international
price of $.25, consumption exceeds production by 80
loaves indicating that imports must be 80 loaves.
Saxony will export bread because, at the international
price of $.25, production exceeds consumption by 80
loaves indicating that exports must be 80 loaves.
c.
Gain in consumer surplus = areas a + b + c = (a + b)
+ c = ($.35 x 50) + (1/2 x $.35 x 50) = $17.5 + $8.75 = $26.25
Loss in producer surplus = area a = areas (a + b) – b =
$17.5 – (1/2 x 30 x $.35) = $12.25
Net gain because gain in consumer surplus ($26.25)
exceeds loss in producer surplus ($12.25).
d.
Loss in consumer surplus = areas d + e = ($.05 x 10)
+ (1/2 x $.05 x 50) = $.50 + $1.25 = $1.75.
Gain in producer surplus = areas (d + e) + f = $1.75 +
(1/2 x 80 x $.05) = $2.00
Net gain because gain in producer surplus ($2.00)
exceeds loss in consumer surplus ($1.75).
4.
a.
Produce 3 billion barrels per year. Consume 6 billion
barrels per year. Import 3 billion barrels per year.
b.
The U.S. would produce and consume 4 billion barrels per
year at a price of a bit over $24 per barrel.
c.
U.S. producers would gain from eliminating oil imports
because they would produce more (4 billion barrels a year without
trade compared with 3 billion with free trade) and charge a higher
price (a bit more than $24 without trade compared with $18 with
trade). U.S. consumers would lose because they would pay a higher
price (a bit more than $24 without trade compared with $18 with
trade) and consume fewer barrels of oil (4 billion barrels a year
without trade compared with 6 billion with free trade).