Question: India has an import-competing auto sector that operates under perfectly competitive conditions. Currently, there are no restrictions on auto imports, or any taxes or subsidies.

India has an import-competing auto sector that operates under perfectly competitive conditions. Currently, there are no restrictions on auto imports, or any taxes or subsidies. Auto production in India is subject to a positive production externality.

a. Give some examples of positive production externalities in a sector like the automotive sector in a developing country

b. An economist has calculated that the value of the positive externality is 5 Rupees per car. What optimal policy should she recommend to the government? Why?

c. The world price of autos is 100 Rupees. The current consumption level of autos is 300 cars. The domestic industry produces 150 cars. The domestic demand elasticity for cars is 2 while the domestic supply elasticity for cars is 1. Calculate the new equilibrium levels of production, consumption, and imports under the policy recommended in the previous section. Calculate also the net welfare benefits from this policy.

d. Now suppose that the government does not follow your advice and chooses an import tariff of 5 Rupees per car instead. How does this outcome differ from the outcome in (c)? Calculate the net welfare effect of the import tariff policy. Explain your result. Why does this policy do worse than the optimum policy?

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Answer A i Production externality refers to a side effect from an industrial operation such as a paper mill producing waste that is dumped into a river ii Production externalities are usually unintend... View full answer

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