Another tough protection question (2019 HSC)

In the NSW Economics HSC, questions 19 and 20 are typically the trickiest multiple choice. This was the case in the 2019 Economics HSC exam. 

This is the graph that applies to both questions.

Even before I’ve looked at Q19, this is how I annotated the question.

You can see from the question that the world price is $3. Point A represents domestic supply and point B represents domestic demand. This gives us a shortage of domestic demand of 40,000 units. This gap will be filled by imports (the distance between point A and point B).

Another point that can be useful to know is point C. This is where domestic demand equals domestic supply and imports equals zero (there are NO imports).

I think we’re ready to try Q19. You can see my annotations below.

In Q19, the first bit of relevant info is that the government wants to impose a tariff that will keep imports to 20,000 units. This is the point of an import quota of 20,000 units: imports will be limited to 20,000 units ONLY.

Go back to the original graph. Imports will equal 20,000 at a price of $4. Check for yourself: at $4, domestic supply is 30,000 while domestic demand is 50,000 — imports of 20,000 will fill the gap.

So, how does the government go from a world price of $3 to an artificial price of $4? It imposes a tariff of $1 per unit. In other words, the tariff price will be $4 (world price of $3 plus the tariff of $1).

The focus of the question is about the total tariff revenue that will be generated for the government. The formula for this is = the size of the tariff * the number of imports.

In this question it will be $1 * 20,000 = $20,000. Your answer is C.

Now, time for the trickier one. Time for Q20. Here’s my annotations and then I’ll walk you through it.

This is a tough one, so let’s go slow.

Our starting point is the world price — which is $3.

At $3, we know that the size of imports is 40,000 units. 

If there are NO IMPORTS, which is the focus of the question, domestic supply must equal domestic demand. At the world price ($3), domestic demand is 60,000 and domestic supply is 20,000. For there to be NO IMPORTS, domestic supply will need to equal 60,000.

Go back to the original graph. Where does domestic supply equal 60,000 units? When price is $7.

Therefore, if the world price is $3, the government must pay a subsidy of $4 per unit to raise the price to $7 and ensure domestic production is 60,000 units. Your answer is D. 

Questions in the comments!