A small country that currently does not trade with the rest of the world has
supply and demand curves for apples as follows:
QD = 12 – P P: $ / lb. of apples
QS = 2P Q: lbs. of apples
a. Calculate equilibrium price and quantity in this country’s market for apples.
b. Under pressure from apple growers, the government puts a per-unit subsidy on
the apple market that results in a new equilibrium quantity of 10 lbs. of apples.
i. The per-unit subsidy required to achieve this new equilibrium
quantity of 10 apples.
ii. The government’s expenditure under such a subsidy plan.
c. The finance minister argues that canceling the subsidy and entering the world
market for apples can pacify apple growers while saving the government money.
He reports that the world price of apples is currently $5/lb of apples.
With a well-labeled graph, show that the finance minister is right. Briefly
explain why apple producers are equally happy with either the subsidy or the free
trade result. Does the government save money? Is society better off under the
subsidy plan or under free trade? Why? [A welfare table is NOT necessary
d. The finance minister returns an hour later with the discovery that domestic apple
supply is MORE elastic than previously thought. If supply is more elastic, which
of the following two plans would domestic apple producers prefer now:
i. No ability to trade in the world apple market, but a per-unit
subsidy that results in an equilibrium quantity of 10 lbs. of apples.
ii. No subsidy, but entrance into the world market for apples with a
world price of $5 / lb. of apples.
Prove your answer with the help of a new, well-labeled diagram. NO
calculations are required here! Domestic apple producers have a clear preference
here. SHADE on this diagram the area that represents the reason producers
would choose one plan over the other.