PAI 723 Economics for Public Decisions > Exercise 4


Here are notes on the solution. As with some of the other solution sheets, most of the algebra is omitted and the explanations are a bit terse. If you have any questions, please don't hesitate to stop by during office hours or the lab session to talk over things in detail.

  1. The price will fall to $0.12 since the world supply is perfectly elastic. That's a 50% drop in the price. Using the price change and the supply elasticity for the US gives the change in US production: 1.5*(-50%) = -75%. US output thus drops to 0.25*14 = 3.5 billion pounds. Using the price change and the demand elasticity to find the change in the quantity consumed: (-0.3)*(-50%) = 15% increase. Consumption thus rises to 1.15*18 = 20.7 billion pounds. The quantity imported is the difference: 20.7 - 3.5 = 17.2 billion pounds.
  2. The overall market graph is shown below. Consumer surplus would increase by areas A+B+C+D. The producer surplus received by US producers would drop by area A and the producer surplus received by foreign producers would drop by area C.

    It's also OK to answer this question by drawing three separate diagrams: one for buyers, one for domestic firms and one for foreign firms. Those diagrams look like this, where the change in CS is E+D (and E=A+B+C in the previous diagram):

    The problem does not ask you to report the values of the areas but in case you calculated them anyway to prepare for the next question, they are as follows (rounded to the nearest $10 million): A = $1.05 billion; B = $630 million; C = $480 million; and D = $160 million.

  3. Gain in CS: $2.32 billion; loss of PS to US producers: $1.05 billion.

    Magnitudes are large in absolute value (billions of dollars, not merely millions). Effect on the industry is dramatic: the transfer to producers ($1.05 billion) is about a third of the entire revenue of the US sugar industry ($0.24 times 14 billion); the lost CS nearly doubles the cost of sugar to consumers. Gain in CS is more than twice loss of PS. Policy is highly inefficient: a different policy that transferred $1.05 billion directly from consumers to producers would leave producers just as well off but would save consumers $1.27 billion.

    Effect on politics is a bit subtle: the policy raises costs to consumers but no individual spends much on sugar; only a small number of firms produce sugar and the policy increases profits substantially. Would expect that sugar producers would lobby much harder to preserve the limits than consumers would lobby to remove them. The policy is probably one of the reasons for the widespread use of corn syrup in soft drinks, by the way.

  4. Exporters with licenses earn $480 million in extra PS when the limit is in place; eliminating the restriction would lower their PS accordingly. Other sugar producers outside the US would be better off: they would be able to sell more sugar to the US but more importantly, the increase in the US demand for sugar imports would raise the world price of sugar.
  5. DWL: $790 million.
  6. Jobs saved: 12,000; lost CS from above: $2.32 billion; lost CS per job saved: $193,500.
  7. Bad policy: very expensive policy for what it accomplishes. Loss to US consumers beyond the $1.05 billion transferred to US producers is 1.27 billion: $790 million in DWL plus $480 million to exporters with licenses. Cost per job saved is enormous: most people whose jobs would be saved earn far less than $193,500; they would strongly prefer a direct payment of a much smaller amount instead. Eg, $50,000 cash instead of a policy that costs $193,500 to preserve a job that pays probably $35,000.
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Peter J Wilcoxen, The Maxwell School, Syracuse University
Revised 09/25/2012