Question 3 (Export subsidy in a small country) Suppose Ethiopia's demand and supply curves for coffee are = D* 90 20P; S* = 30 + 20P a) Find the autarky equilibrium price of coffee and the quantity bought and sold in Ethiopia. b) Now suppose the world price of coffee is 2 and Ethiopia is a small country which cannot affect the world price of coffee. If Ethiopia opens up to trade and practices free trade in coffee what is going to be the price of coffee in Ethiopia? How much coffee will Ethiopia export? c) Calculate the impact of opening to trade on the welfare of Ethiopia. Show your results diagrammatically. d) Now suppose Ethiopia decides to subsidize the export of coffee. In particular, it gives an export subsidy of 0.5. What happens to the domestic price of coffee in Ethiopia? e) With the export subsidy of 0.5, what happens to the production, consumption and export of coffee in Ethiopia? f) Calculate the welfare implications of an export subsidy of 0.5 compared to the free trade situation.

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