Chapter 9, Problem 9.4.11PA

Explanation:

Figure 1 illustrates the impact of world price and domestic price that creates trade diversification and creation.

Figure 1

Figure 1 depicts the demand and supply of kumquats in the U.S. market after the quota restriction is imposed. Horizontal axis represents the quantity of kumquats in millions of pounds and the vertical axis represents the price in dollars per pound. The U.S. government imposes a quota of import of 6 million pounds of kumquats to the U.S. each year.

Using Figure 1, Table 1 is filled as follows:

Table 1

	Without Quota	With Quota
World price of kumquats	$0.75	$0.75
U.S. price of kumquats	$0.75	$1.00
Quantity supplied by U.S. firms	4 million	6 million
Quantity demanded	13 million	12 million
Quantity imported	9 million	6 million
Area of consumer surplus	A + B + C + D + E + F	A + B
Area of domestic producer surplus	G	C + G
Area of deadweight loss	No deadweight loss	D + F

When there is no quota, the quantity demanded is 13 million pounds of kumquats; out of which 4 million pounds is supplied by U.S. firms and rest 9 million pounds of kumquats $(=13-4)$ are imported. When quota restriction of 6 million pounds of kumquat is imposed, 6 million pounds only can be imported against 12 million pounds of quantity demanded, rest 6 million pounds $(=12-6)$  is supplied by the U.S. firms at U.S price of $1.

Consumer surplus is calculated as the area below the demand curve and above the market price. So, area of consumer surplus without quota is between market price of $0.75 and the demand curve, which is the sum of the areas A, B, C, D, E and F. The producer’s surplus is between U.S supply curve (above) and market price (below), which is the area G. With quota, consumer surplus is between price $1 and U.S demand curve, which is the sum of areas A and B, and the producer’s surplus which is increased by quota is the sum of areas C and G. There is no deadweight loss, if quotas are not imposed. With quota areas D and F denote the deadweight loss.

Concept introduction:

Quota: It is the numerical limit that a government imposes on the quantity of goods that can be imported into a country.

Consumer surplus:  It is the monetary gain attained by a consumer, which is calculated as the difference between the price a consumer pays for the product and the price he would be willing to pay rather than do without it.

Producer surplus: It is the benefit attained by a producer by selling a product, which is calculated as the difference between the amount that a producer is willing to supply goods for and the actual amount received by him, when he makes the trade.

To determine

Measuring the economic effects of a quota.