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International Trade and Protectionism: Question 8

Syllabus 6.2

Structured AS 8 marks

Solvenia is a small economy that buys rice on the world market at a fixed world price of $10 per sack; because Solvenia's own demand and supply are small relative to the world market, its purchases do not change this world price. Table 1 shows Solvenia's domestic demand and supply schedule for rice, in thousands of sacks per year, at different prices.

Table 1: domestic demand and supply of rice in Solvenia

Price ($ per sack) Quantity demanded (thousand sacks) Quantity supplied (thousand sacks)
10 100 40
12 90 50
14 80 60
16 70 70
18 60 80

(a) At the free trade world price of $10 per sack, use Table 1 to state the quantity demanded, the quantity supplied, and hence the quantity of rice imported. [2]

(b) The government now imposes an import quota that limits rice imports to 20,000 sacks per year. Use Table 1 to identify the new domestic equilibrium price consistent with this quota, and state the resulting quantity demanded and quantity supplied at that price. [3]

(c) Compare how the price paid by consumers and the quantity supplied by domestic producers change as a result of the import quota, relative to the free trade situation in part (a). [3]

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Worked solution

Part (a): Imports before the quota

Reading the row for the world price of $10 in Table 1: quantity demanded is 100 thousand sacks and quantity supplied is 40 thousand sacks. Since Solvenia is a small economy trading freely at the fixed world price, the gap between what domestic consumers want to buy and what domestic producers are willing to supply is met by imports:

imports=Qd−Qs=100−40=60 thousand sacks per year\text{imports} = Q_d - Q_s = 100 - 40 = 60 \text{ thousand sacks per year}

Part (b): Finding the price at which the quota binds

An import quota of 20,000 sacks (20 thousand sacks) means the gap between quantity demanded and quantity supplied can be no larger than 20 thousand sacks. Imports above the world price of $10 are no longer allowed to fill the whole gap of 60 thousand sacks, so the domestic price must rise until the gap shrinks to exactly the quota amount.

Checking each row of Table 1 for Qd−Qs=20Q_d - Q_s = 20:

At a price of $14: Qd−Qs=80−60=20 ✓Q_d - Q_s = 80 - 60 = 20 \ \checkmark

So the new domestic equilibrium price is $14 per sack, with quantity demanded of 80 thousand sacks and quantity supplied of 60 thousand sacks; the 20 thousand sack gap between them is exactly filled by the quota-restricted imports.

Part (c): Comparing the quota outcome with free trade

Free trade (a)With 20,000 sack quota (b)
Price$10$14
Quantity demanded100,000 sacks80,000 sacks
Quantity supplied (domestic)40,000 sacks60,000 sacks
Imports60,000 sacks20,000 sacks

Restricting imports to 20,000 sacks pushes the domestic price up, from $10 to $14 per sack, because consumers can no longer buy as much cheap imported rice as they would like at the world price. Domestic producers respond to this higher price by expanding their own output, from 40,000 sacks to 60,000 sacks, a rise of 20,000 sacks. At the same time, the higher price discourages some domestic consumption, so quantity demanded falls from 100,000 to 80,000 sacks.

Final answers

  • (a) Qd=100Q_d=100 thousand sacks, Qs=40Q_s=40 thousand sacks, imports == 60 thousand sacks.
  • (b) New price == $14 per sack; Qd=Q_d= 80 thousand sacks, Qs=Q_s= 60 thousand sacks.
  • (c) Price rises from $10 to $14; domestic quantity supplied rises from 40,000 to 60,000 sacks.