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BUS102 Introduction To Microeconomics Assignment

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Question:

Suppose that the government decides to subsidise exports of beef by paying a certain amount for each kg sold overseas. How does this export subsidy affect the domestic price of beef, the quantity of beef produced, the quantity of beef demanded, and the quantity of beef exported?
 
How does it affect consumer surplus, producer surplus, total surplus and government revenue? Illustrate your answer with a supply and demand diagram.
 
Suppose Canada imposed an import quota on Australian beef. Draw a graph and explain how this quota would influence the consumer prices of beef in Canada, consumer surplus (CS) and producer surplus (PS), benefits of beef importers, and the amount of deadweight loss in Canada.
 
State and discuss two arguments that could be advanced in support of trade protection.
 
 

Answer:

Introduction:

Under a free trade agreement between Australia and Canada, it is agreed between the two countries that Australia will be exporting beef to Canada:

If the government of Australia provides an export subsidy to those beef sellers who are exporting beef to Canada, then the export cost of beef will fall, which in turn will help the beef producers to charge less from the residents of Canada. However, due to the increase in the quantity exported, the domestic price will increase, as the domestic supply will tend to decrease (Gopinath, Helpman and Rogoff 2014). This fall in the domestic supply of beef will lead to an excess demand for beef in the domestic market of Australia. This excess demand in the domestic market, clubbed with the increase in the demand in market of Canada (due to a lower price attributed to the export subsidy), the sellers will be encouraged to produce and supply more (Gandolfo 2013).

The effects of the export subsidy of the Australian government on beef, on the producer surplus, consumer surplus and the government revenue can be explained with the help of the following demand and supply diagram:

As can be seen from the above diagram, Pw shows the equilibrium price level at the free trade situation, where the excess demand of beef in Canada is equal to the excess supply of the same in Australia. However, with the imposition of an export subsidy, the price of beef is increased in Australia, to Ps and the same is decreased in Canada to Ps’ (Dahl 2017). Due to the increase in the domestic price of beef in Australia, the domestic consumer surplus decreases by the amount (a+b). Due to the imposition of export subsidy, the producer surplus increases by (a+b+c). As the government provides export subsidy to the producers, the government revenue is actually negative which is of the amount (b+c+d+e+f+g) (Florio 2014).

Import quotas are imposed on goods and services to restrict the amount of import and encourage the domestic suppliers to produce more. By imposing an import quota on beef, the Canadian government will restrict the supply of beef from Australia to Canada, thereby increasing the price of the same in the latter (Anderson 2012). The effects of import quota on beef on the consumer surplus, producer surplus, the dead weight loss of the country can be shown with the help of the following diagram:

Due to the imposition of an import quota on beef, the price of the commodity in Canada increases from P0 to P1 as the supply of beef is now restricted in the country. Thus, due to the imposition of import quota, the consumer surplus in the country decreases by the amount (A+B+C+D). The increased price increases the producer surplus by the amount A. The dead weight loss is of the amount of (B+C+D), as the part D becomes the profit of the foreign suppliers only (Diamond and Rothschild 2014).

Trade protection policies are taken by the government in order to protect the domestic producers and encourage them to increase their domains by protecting them from foreign competition. It helps the economy of the country in the long run, by increasing the productivity, employment and overall welfare of the people. Trade protective policies also imposed in order to diversify their businesses and it also helps the country to improve its balance of payment situations. Imposition of trade protection in terms of tariffs also helps in increasing the government revenue of the country in terms of import tariff and other taxes (Shatz and Tarr 2017).

Infant Industry Argument- The trade protection policies help the infant industries (whose initial cost of protection is higher than international standards) to increase their production and achieve cost efficiencies.

Business Diversification Argument- In presence of excessive specialization under free trade framework, the country becomes dependant on many countries for most of its products and services. Trade protection on the other hand, helps the country to diversify its goods and services, thereby making it self sufficient in the long run (Hillman 2013).

The commodity Alcopops, being a commodity of addictive nature, the demand of the same is not highly dependent on the price level of the same. People who are addicted to Alcopops will try to buy it at any price, as the demand for the same increases with the increase in the addiction. Therefore, the outcome of the imposition of tax on Alcopops, which was done to reduce the demand for the same and to increase the government revenue, has not been as expected (Rios, McConnell and Brue 2013). This is mainly because the demand for the same is highly inelastic to the changes in the price of the same. This can be explained with the help of the following diagram:

As can be seen from the above figure, the imposition of tax, though shifts the supply curve upwards, however, the demand for the same does not decrease proportionately as the increase in the price due to the imposition of the tax.

However, in this case, as the demand is highly inelastic, the imposition of tax does not decrease the demand significantly. However, with a higher price and a comparatively less decrease in the demand, the tax collection is expected to be high. In this case, the less than expected revenue collection of the government from the imposition of the tax is surprising (Canto, Joines and Laffer 2014).

 

Alcopops being a commodity with inelastic demand, the imposition of tax on the commodity raises the price from P1 to P2. However, the producers receive P3 and not P1. Here, P2P3 is the total amount of tax imposed on per unit of the commodity. However, as the demand for the same is highly inelastic, the imposition of tax increases the price of the commodity considerably, but the demand for the same does not decrease proportionately. As the demand for the same is inelastic, the tax burden is easily shifted on the consumers from the producers. Thus, in this case, the consumers bear more of the tax burden than the producers (Eichhorn 2013).

As the imposition of tax could not decrease the demand for the commodity considerably and as much of the tax burden is borne by the consumers, therefore, the outcome of tax imposition was not efficient in this case.

The imposition of tax on the inelastic demand of Alcopops did not work effectively as the demand did not decreased significantly. In this case, the other policies, which can help the government of the country to decrease the demand for the same, is by the imposition of quota on the total production and supply of the product. Other policies, which can be adopted by the government, are that of awareness generation among the teenagers. The government does the same by spreading these programs in the schools and colleges (Davis 2013). There should be adequate training for the teachers as well as the parents for controlling the addiction of the teenagers without forcing them. There should be the increase in the minimum legal age for the consumption of the same and should also impose duties and import tariffs on these types of commodities.

 

References

Anderson, B.M., 2012. Economics and the public welfare. Liberty Fund.

Canto, V.A., Joines, D.H. and Laffer, A.B., 2014. Foundations of supply-side economics: Theory and evidence. Academic Press.

Cordato, R., 2013. Welfare economics and externalities in an open ended universe: A Modern Austrian Perspective. Springer Science & Business Media.

Dahl, R.A., 2017. Politics, economics, and welfare. Routledge.

Davis, J.B., 2013. The theory of the individual in economics: Identity and value. Routledge.

Diamond, P. and Rothschild, M. eds., 2014. Uncertainty in economics: readings and exercises. Academic Press.

Eichhorn, W. ed., 2013. Measurement in Economics: Theory and Applications of Economics Indices. Springer Science & Business Media.

Florio, M., 2014. Applied welfare economics: Cost-benefit analysis of projects and policies (Vol. 22). Routledge.

Gandolfo, G., 2013. International Economics II: International Monetary Theory and Open-Economy Macroeconomics. Springer Science & Business Media.

Gopinath, G., Helpman, E. and Rogoff, K. eds., 2014. Handbook of international economics (Vol. 4). Elsevier.

Hillman, A.L., 2013. The political economy of protection. Taylor & Francis.

Rios, M.C., McConnell, C.R. and Brue, S.L., 2013. Economics: Principles, problems, and policies. McGraw-Hill.

Shatz, H.J. and Tarr, D.G., 2017. Exchange rate overvaluation and trade protection: lessons from experience. In Trade Policies for Development and Transition (pp. 115-127).

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