ARE120 Homework 5 Solution
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?