2. Suppose there is a small, closed economy that produces bananas. The domestic demand and domestic supply curves for bananas in this small, closed economy are given as:

Domestic demand: P = 20 - (1/2)Q

Domestic supply: P = 2 + (1/10)Q

a. (2 points) What is the equilibrium price and quantity of bananas in this small, closed economy?

To find the equilibrium price and quantity simply use the demand and supply curves. Thus, 20 - (1/2)Q = 2 + (1/10)Q and solving for Q, we get Q = 30 units. Using this quantity in either the demand or the supply equations we can find the price: P = $5.

b. (2 points) Suppose that the world price of bananas is $8 per unit of bananas and this economy opens to trade. Provide a numerical measure of this country's imports or exports of bananas once the market is open to trade.

If the world price is $8 per unit of bananas and this economy opens to trade, then at $8 domestic demanders will demand 24 units of bananas. At $8, domestic suppliers will supply 60 units of bananas. The excess supply of 36 units of bananas will be exported.

c. (2 points) If this closed economy opens its banana market to trade with the world price of bananas equal to $8 per unit of bananas, what will be the change in consumer surplus due to this decision?

CS when the banana market was closed to trade was equal to (1/2)($20/unit of bananas - $5/unit of bananas)(30 units of bananas) = $225. CS when the banana market is open to trade is equal to (1/2)($20/unit of bananas - $8/unit of bananas)(24 units of bananas) = $144. The loss is consumer surplus when the banana market opens to trade is equal to $81.

d. (2 points) Suppose that the world price of bananas is $2.50 per unit of bananas. If this market opens to trade, what will be the level of imports or exports of bananas?

When the world price is $2.50 per unit of bananas domestic demanders will demand 35 units of bananas while domestic suppliers will supply 5 unit of bananas. The excess demand for bananas of 30 units will be met by importing 30 units of bananas into this small economy.

e. (2 points) Given the scenario in part (d), what will be the change in consumer surplus when this economy goes from being a closed economy with regard to the banana market to being an open economy with regard to the banana market?

CS when the banana market was closed to trade was equal to (1/2)($20/unit of bananas - $5/unit of bananas)(30 units of bananas) = $225. CS when the banana market is open to trade is equal to (1/2)($20/unit of bananas - $2.5/unit of bananas)(35 units of bananas) = $306.25. The gain in CS from opening the market to trade: the gain in CS = $81.25

f. (4 points) Suppose that the world price of bananas is $2.50 per unit of bananas and that this economy is open to trade. Suppose the government implements a tariff of $1.00 per unit of bananas. Calculate the tariff revenue from the implementation of this policy and the deadweight loss from the tariff.

With the tariff the price of bananas rises to $3.50. At this price 15 units of bananas will be supplied domestically and 33 units of bananas will be demanded domestically. The small country will therefore import 18 units of bananas and collect a tariff of $1/unit of bananas on these imports. Tariff revenue is therefore equal to ($1.00/unit of bananas)(18 units of bananas) = $18. Deadweight loss is equal to (1/2)($3.50/unit of bananas - $2.50/unit of bananas)(15 units of bananas - 5 unit of bananas) + (1/2)($3.50/unit of bananas - $2.50/unit of bananas)(35 units of bananas - 33 units of bananas) = $6.

g. (2 points) Suppose the government wishes to replace the tariff described in part (h) with a quota that results in the same consumer surplus as the consumer surplus with the tariff, the same producer surplus as the producer surplus with the tariff, and the same deadweight loss as the deadweight loss with the tariff. How many units of bananas should the quota equal for this result? Explain your answer.

With the tariff the small economy imported 4 units of bananas. If the quota was set at 18 units of bananas then the quota would have the same impact as a tariff of $1.00/unit of bananas on consumer surplus, producer surplus, and deadweight loss.

For part G why is there only 4 imported units of banana?