Suppose Demand is P=100-3Q and supply is
P=Q. Draw this demand and supply diagram for a closed economy (no imports or
exports are possible) with the standard axes (P vertical, Q horizontal). Mark
carefully on the diagram (for one mark each) the demand curve, the supply
curve, and then work out the equilibrium (the numbers are required, not just
showing the point).
Question 5 (7 marks) Consider a market described by these demand and supply curves with the production and consumption externalities described in Question 4, and exploring the cases when the world price is 20 or 30. Does free trade always improve welfare? (1 mark) To answer this question do the following welfare calculations (1 mark for each) and see if the trade situations have higher welfare than the autarky situation. (Remember, when free trade is allowed, the world price might be above, or below, the autarky price, which is why we have to consider both cases if we want to generalize about free trade.) For the production externality case calculate welfare in the following cases: (i) no trade with only a production externality vs (ii) importing with only a production externality and (iii) exporting with only a production externality . Then consider the consumption externality case by calculating welfare in the following cases (again, 1 mark each) (iv) no trade with only a consumption externality vs (v) importing with only a consumption externality and (vi) exporting with only a consumption externality. Your measure of welfare should always be Consumer Surplus (CS, i.e. area below demand above price) + Producer Surplus (PS, i.e. area above supply curve and below price) + any externality (which is negative in both cases).
i) no trade with only a production externality