The figure given below shows the market for MP3 players in a small country. D_d and S_d are the domestic demand and domestic supply curves of the MP3 players before the imposition of the quota. (S_d + Q_Q) is the total available domestic supply curve after the quota has been imposed. According to the figure, if import licenses are allocated based on a resource-using procedure, the loss to the economy will be:

Question

Quizplus · Accepted Answer

Before the quota was imposed, the equilibrium quantity of MP3 players was Q1 and the equilibrium price was P1. However, after the quota has been imposed, the domestic suppliers can only supply QS1U1B1-QD1U1B1 quantity at the same price P1. Thus, there is a shortage of Q1-QS1U1B1+QD1U1B1 MP3 players in the market.

If import licenses are allocated based on a resource-using procedure, then the surplus of MP3 players will be allocated to those firms who use more resources to produce MP3 players. This implies that the marginal cost of production of these firms will be higher than the marginal cost of production of firms who use fewer resources to produce MP3 players.

Now, the cost of producing each additional unit of MP3 players depends on the technology used by the firms. If some of the firms use a more efficient technology, then they can produce MP3 players at a lower cost than the firms who use an inefficient technology.

Thus, if the import licenses are allocated based on a resource-using procedure, then the firms who use more resources to produce MP3 players will get the import licenses. This implies that the more efficient firms will produce less, and the less efficient firms will produce more.

As a result, the total cost of production will increase, and the domestic price of MP3 players will rise to P2. This will reduce the domestic quantity demanded to Q2. The domestic suppliers will supply QS1U1B1-QD1U1B2 quantity of MP3 players, and the shortage will be reduced to Q2-QS1U1B1+QD1U1B2.

The loss to the economy will be the difference between the consumer surplus before and after the quota. The consumer surplus before the quota was imposed was the area below the demand curve DS1U1B1dS1U1B0 and above the equilibrium price P1, up to the quantity Q1.

After the quota has been imposed, the consumer surplus will be the area below the demand curve DS1U1B2dS1U1B0 and above the equilibrium price P2, up to the quantity Q2.

The difference between the two consumer surpluses is approximated by the area of the triangle P1P2B, which is equal to (P1-P2) x (Q1-Q2)/2.

Thus, the loss to the economy will be the difference between the consumer surplus before and after the quota, plus the deadweight loss due to the reduction in total surplus.

The deadweight loss is approximated by the area of the triangle BQ2QD1U1, which is equal to (P1-P2) x (QS1U1B1-QS1U1B2)/2.

Therefore, the total loss to the economy will be more than $35 million. Hence, the correct answer is C.

The Figure Given Below Shows the Market for MP3 Players