Question 2 (35 Points)

(a) Assume Australia's supply (S) and demand (D) for butter is represented by the following equations where P is domestic price per tonne, and quantities are in tonnes [15 Points]:

DA = 750 -25P

SA = 100 +30P

Now consider New Zealand, an exporter of butter, with the following demand and supply functions

DNZ = 180 - 5P

SNZ = 50 + 33P

1. Derive Australia's import demand function.

2. Derive New Zealand's export supply function.

3. Assuming bilateral trade between the two countries identify

a. The world price

b. The quantity traded

(b) Suppose that Australia decides to encourage butter imports from New Zealand by imposing an import subsidy of $1. Calculate the effect of the tariff on [20Points]:

1. The price of butter in each country

2. The quantity of butter supplied and demanded in each country and

3. The volume of trade

4. Use graphical analysis to illustrate the impact of the import subsidy on the welfare of Australia's consumers, producers, and government, compared to the situation of free trade (you do not need to calculate this numerically).