ARE120 HOMEWORK 5 SOLUTION – LATEST 2016
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ARE120 Homework 5
Solution – Latest 2016
On the island of Tasmania, suppose the milk
market is characterized by the following conditions: (a) freely transferable
marketing quotas apply to milk sold for consumption as fluid (fresh) milk in
Tasmania, at a price Pf, (b) additional milk production, beyond the fresh milk
quota, is sold at the price for milk used in manufacturing, Pw which is lower
than the fluid milk price, (c) Tasmania is a price taker at the world market
price for manufactured dairy products, and (d) the fluid milk premium is
sustained by natural protection provided by Bass Strait (full of sharks)
between Tasmania and mainland Australia, and an embargo on fresh milk imports
from mainland Australia.
- Draw a supply and demand diagram to illustrate the
economic consequences of introducing the quota policy on quantity produced,
consumed, and traded, relative to a situation without a quota program.
Also, in a table, describe the consequences of the quota policy for
welfare of fresh milk consumers, milk producers, and quota owners, in
Tasmania relative to a situation without a quota program, in terms of
areas on your diagram. Who gains and who loses from the quota policy?
- Suppose the Tasmanian Milk Marketing Board undertakes a
fresh milk promotion campaign funded by a tax of t per unit, collected on
all of Tasmania’s milk production. The advertising increases consumer
willingness to pay for milk by m per unit. On your diagram, show the
impacts of the advertising-induced increase in demand, and the tax used to
finance it, on (a) the positions of supply and demand, (b) and the prices
of milk sold for fresh and manufacturing purposes, (c) the total quantity
of milk, and (d) its allocation between fresh and manufacturing uses. Use
the labels m and t to indicate the magnitudes of the relevant shifts. In a
table, describe the consequences of the tax-funded advertising program for
the welfare of fresh milk consumers, milk producers, and quota owners,
relative to no tax-funded advertising program, in terms of areas on your
diagram. (Assume consumer surplus is equal to the usual area, behind the
relevant demand, with or without the advertising-induced shift.) Who gains
and who loses from the tax-funded advertising policy in the presence of
the quota policy?
- Suppose the government eliminates the fresh milk quota
and does not pay any compensation to quota owners, but the Tasmanian Milk
Marketing Board continues to sustain its fresh milk promotion program
funded by a tax of t per unit, collected on all of Tasmania’s milk
production. In general terms, what are the implications of the elimination
of the quota program for the total benefits and costs of the
tax-advertising policy and its distribution between milk consumers, milk
producers, and milk quota owners? (Hint: To answer this question you
should contrast the consequences of the tax- advertising policy between
the with-quota and without-quota scenarios.) What does this analysis tell
you about the returns to generic promotion by a producer group in a small,
open-economy setting?
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