The nation of Acirema is "small", and unable to affect world prices. It imports peanuts at the price of \(\$ 10\) per bag. The demand curve is $$D=400-10 P$$ The supply curve is $$S=50+5 P$$ Determine the free trade equilibrium. Then calculate and graph the following effects of an import quota that limits imports to 50 bags. a. The increase in the domestic price. b. The quota rents. c. The consumption distortion loss. d. The production distortion loss.

In the context of international trade, free trade equilibrium is a situation where a country imports and exports goods without any trade barriers such as tariffs, quotas, or subsidies. This equilibrium occurs where the domestic demand for a good meets its supply at a market price that also equals the world price.

In our example with the nation of Acirema, to determine the free trade equilibrium, we equate the demand and supply functions. Solving for the equilibrium price (P) and quantity (Q) gives us the point where the market is in balance without any trade restrictions. This scenario enables us to understand the actual market dynamics before any intervention, like a quota, is introduced. It sets a baseline for comparison to measure the impact of such trade policies on the domestic market.

Quota rent calculation is essential to comprehend because it represents the economic benefit gained by those who receive the right to import under a quota. This benefit is essentially extra revenue that is earned from being allowed to sell a limited quantity of goods at a higher price than the world price.

To calculate the quota rent, you would subtract the world price from the domestic price after the quota is imposed. Then, multiply this difference by the quantity of the quota. Thus, this calculation gives policymakers and economists insight into the financial gains that importers or license holders receive from the quota system. This concept is critical because it sheds light on one aspect of the costs of protectionist measures and who benefits from them.

When a quota is imposed on imports, it causes distortion losses in the market. These are efficiency losses that occur because the quota drives a wedge between the domestic price and the world price. There are two types of distortion losses: consumption distortion loss and production distortion loss.

Consumption Distortion Loss

Consumption distortion loss happens when consumers pay more and consume less due to the higher prices after the quota. It is represented as the area of a triangle in the demand curve diagram.

Production Distortion Loss

Production distortion loss occurs because domestic producers are encouraged to produce more than the efficient level, given that they receive a price signal distorted by the quota. This inefficiency is illustrated as a triangle on the supply curve diagram. These calculations help to quantify the cost of trade policies on society.

Determining market equilibrium after the introduction of a trade policy like an import quota requires the analysis of how the policy affects the supply and demand in the market. By restricting imports, the quota effectively reduces supply, which can raise prices and alter the quantity of goods sold in the market.

To determine the new equilibrium, the modified supply curve, including the quota, is set equal to the demand curve. The intersection of these curves gives us the new equilibrium price and quantity. This new equilibrium reflects the overall market conditions after policy enforcement, and understanding this helps evaluate the trade policy's effect on the domestic economy. It's crucial for students to grasp this concept to understand the outcomes of government intervention in free markets.