1 Savings, Investment, and the Current Account If a country’s current account is in deficit today (period 1), what does this mean for the
September 9, 2020
In your own words answer the following questions and upload your answers within an MS Word Document.
September 9, 2020

 The government of Optima, a small developing country which cannot affect world prices, wishes to achieve self

sufficiency in food so that domestic production is enough to cover caloric needs. At present, food is imported while Coffee is

exported. If self sufficiency involves producing at least X  units of food at home where X  is more than the current production

levels. The Finance Minister proposes attaining self sufficiency by putting a tariff on imports of food and raising the tariff

until the country is self sufficient. The Minister for Agriculture suggests a subsidy to the production of food. He argues

that this would not hurt consumers and so is the best way for production to be raised and the least cost way of attaining

self sufficiency as defined above.


(i)  Draw the demand and supply of food as a function of the domestic price of food keeping the price of coffee fixed,

the imports of food and label the point X .

(ii)  The equilibrium with the Finance minister’s proposal.

(iii)  The equilibrium with the Agriculture minister’s proposal.

(b)  Assuming that welfare is the sum of consumer surplus, producer surplus and net government revenue what is the

change in welfare

(i)  For the Finance Minister’s proposal being implemented.

(ii)  The Agriculture Minister’s proposal being implemented.

(iii)  What is your recommendation to the government?

(c)  How is your answer related to the principle of targeting?

(d)  If it was very costly to raise revenue, how would your answer be affected?

(e)  Suppose the target was to import  no more than DF . What would the optimal policy be? Explain the intuition behind

your answer.

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