Agriculture and Agrifood Canada (AAFC)

    You are an economic policy analyst for Agriculture and Agrifood Canada (AAFC). You are asked to consider the economic impact of an export quota on potash. You assume the domestic demand and supply for potash in Canada are given by the following linear demand and supply functions: 𝑃 𝐷 = 𝛼 − 𝛽𝑞 𝑃 𝑆 = 𝑎 + 𝑏𝑞 where 𝛼, 𝛽, 𝑎, 𝑏 ≥ 0. You conduct an econometric analysis of the domestic supply and demand and determine that the demand and supply functions are as follows: 𝑃 𝐷 = 120 − 2𝑞 𝑃 𝑆 = 2⁄5 𝑞 Canada is a potash exporter. The excess supply function for Canadian potash is the quantity difference between supply and demand at each price, and can be calculated as follows: 𝐸𝑆 = 𝛽𝑎 + 𝛼𝑏 𝑏 + 𝛽 + 𝑇 + 𝛽𝑏 𝑏 + 𝛽 𝑞 where 𝑇 is the transportation cost. You also assume a linear excess demand function, 𝐸𝐷 = 𝐴 − 𝐵𝑞, with the elasticity of 𝐸𝐷 given by: 𝜀𝐸𝐷 = 𝑑𝑞 𝑑𝑝 𝑝𝑊 𝑞 = −1 𝐵 𝑝𝑊 𝑞 , so that 𝐵 = −1 𝜀𝐸𝐷 𝑝𝑊 𝑞 and 𝐴 = 𝑝 𝑊 (1 − 1 𝜀𝐸𝐷 ). You determine that the elasticity of 𝐸𝐷 is equal to − 2 3 , the world price is $60/unit, and the transportation cost is $10/unit. As an economist at AAFC, you are asked to: (a) Determine the effect of international trade in potash on the Canadian economy. In particular, you are asked to calculate the net gain to Canada due to trade (compared to autarky). You are also asked to calculate the impact of potash trade on Canadian consumers and producers of potash. a. What are the formulae for the equations of 𝐸𝐷 and 𝐸𝑆? b. Draw a diagram with a panel for the domestic market and a panel for the international trade market. Plot the domestic supply and demand curves in the domestic panel, and the excess supply and excess demand curves in the international trade panel. Show the gains and losses from trade in each of the panels and provide an actual measure of the net gain to trade. Show the gains/losses to Canadian consumers and producers in the domestic panel. (b) Now suppose that Canada sets an export quota of 36 units of potash. a. What are the total gains or losses (compared to autarky)? b. Is Canada better off with an export quota or with free trade? (c) In reality, Canada has formed an export cartel in potash (two Canadian companies and one US company) in an effort to exploit market power on the world market. In theory, how should you amend your analysis to take this into account?