2. Small Country Export Subsidy In lecture 10, we discussed the welfare implica- tions of export subsidy and production subsidy for a small country. We will look at this problem in more detail here. (11 points total) Consider the following demand and supply system for country C (assume country C is small): Country Cs demand for pizza is: QC= 8 PC. Country Cs supply for pizza is: QC= PC2.

a) Suppose the world price of pizza is $6 per unit and Country C is open to free trade. How many pizzas would Country C export? What is the gain from trade for Country C? (3 points)

b) Suppose the government of Country C wants to promote pizza production and puts a $1 per unit subsidy on each unit of pizza exported. On a demand-supply graph, clearly label the welfare changes in consumer surplus, producer surplus, and government revenue, and the social welfare loss resulted from the export subsidy policy. (4 points)

c) Using the same graph in part b), show that a $1 per unit production subsidy will re- sult in less welfare loss compared to the export subsidy in part b). Moreover, you should know this result even before you do the graphical analysis. Briefly explain why. (4 points)