Question

1. Returns to the Indian cotton trade example. Recall that India’s domestic demand and supply of cotton are QD = 2250 – 300P and QS = – 125 + 250P. The world price is $1 per pound. Recall that quantities are in 1,000s of metric tons (so, for example, a Q of "5" is really 5,000 metric tons of cotton).

(a) SCENARIO 1.
Suppose that instead of a $1 tariff, India imposed a quota of 600. Think of this as increasing QS, that is, at any and every price, there will be an additional 600 units of cotton on the market coming from abroad. What is the total amount of imports under this scenario? What is the prevailing price in India? What is the "tariff equivalent" of the quota? Calculate numerically, and illustrate with a graph.
(b) SCENARIO 2
Now suppose that Indian cotton demand rises to QD = 2850 – 300P, and the 600 unit quota is in place. What happens to domestic price? To imports? What is the "tariff equivalent" of the quota now? Illustrate with a graph and explain.

Answer 1

(a) Under scenario 1, with a quota of 600 units, the total amount of imports would be 600 units. The prevailing price in India can be found by equating the domestic demand and supply equations. So, 2250 - 300P = -125 + 250P. Solving for P, we get P = $6. The "tariff equivalent" of the quota is the amount of the tariff that would yield the same effect on the market. Since the quota increases the supply by 600 units, we can consider it as a tariff on imports of 600 units. To calculate the tariff equivalent, we multiply the additional units (600) by the world price ($1), giving us a tariff equivalent of $600.

(b) In scenario 2, with an increased domestic demand of QD = 2850 - 300P and the 600 unit quota in place, the domestic price would rise. To find the new price, we equate the new demand equation with the supply equation QS = -125 + 250P. Solving for P, we get P = $7. The increase in demand would lead to a higher prevailing price. As for imports, they would still be limited to the quota of 600 units. The "tariff equivalent" of the quota remains the same as in scenario 1, at $600.

In both scenarios, a graph can be drawn to illustrate the changes in the market. The vertical axis represents price, while the horizontal axis represents quantity. The demand and supply curves can be plotted, and the effects of the quota and increased demand can be shown.