Question

The market for frozen shrimp is served by both domestic (D) and foreign (F) producers. The domestic producers have been complaining that foreign producers are dumping frozen shrimp onto the U.S. market. As a result, Congress is very close to enacting a policy that would completely prohibit sales by foreign manufacturers of frozen shrimp in the U.S. market. The relevant supply curves for the frozen shrimp market are : QF = 2000 + 50P QD = 6000 + 150P and the demand curve is: Qd = 50, 000 − 500P where Q = thousands of tons of shrimp per year, and P = price per ton. (a) Currently there are no restrictions covering frozen shrimp. What are the current equilibrium price and quantity? (b) Calculate the price and quantity that would prevail if the proposed policy banning imports is enacted. (c) Write at least one and no more than three complete sentences summarizing your view of the problems that may arise with enacting such a policy, especially with respect to its effectiveness in accomplishing its aims. (d) Draw a carefully-labeled diagram that analyzes the economic welfare implications of the proposed policy

Answer 1

a. Total demand in the domestic market is Q_D = 50,000-500P

and total supply in both domestic and foreign market is Q_S = Q_D' + Q_F

or, Q_S = 6,000 + 150P + 2,000 + 50P

or, Q_S = 8,000+200P

For equilibrium in domestic market with no restrictions on imports,

Q_S = Q_D

or, 8,000 + 200P = 50,000 -500P

or, 700P = 42,000

or, P=$60 (P is the equilibrium price)

and Q = 8,000+200*60 = 20,000 units (Q is the equilibrium quantity)

b. If imports are banned, equilibrium takes place at Q_D = Q_D'

or, 50,000 - 500P = 6,000 + 150P

or, 650P = 44,000

or, P = $67.7 = $68 (approx) where P is the equilibrium price with restrictions

and Q = 6,000+150*68 = 16,200 units where Q is the equilibrium quantity with restrictions

c. This policy provides advantage to domestic producers as they do not have to face any foreign competition and can earn higher profits. But, this policy decreases consumer surplus (as the price rises) which is disadvantageous to consumers.

d.

In the given diagram,

With total supply, consumer surplus = Area (A+B+O) whereas producer surplus = Area C.

But, with domestic supply, only, we can see dead weight loss in the market.

Also, new consumer surplus = Area A and new producer surplus = Area (B+C)

Thus, total welfare falls in the domestic market due to restrictions on imports.