Data
Quantity of imports without trade restrictions: 500,000 units
World price per unit: $20
Domestic price per unit before any restrictions: $30
Proposed tariff: 25%
Proposed import quota: 400,000 units
Demand elasticity for imports: -0.6
a) New imports price per unit with the tariff.
25/100 × 20=$5
$20+$5=$25
b). Quantity demanded of imports after the tariff:
b) Quantity demanded of imports after the tariff:
PED=% change in quantity demanded / % change in price = -0.6
The percentage change in price is:
((25-20)/20) * 100% = 25%
The percentage change in quantity demanded:
Qd=% change in quantity demanded = -0.6 * 25% = -15%
The new quantity demanded will be:
500,000 units * (1 - 0.15) = 425,000 units
c) Total revenue generated by the tariff and consumer surplus loss:
Tariff Revenue:justThe tariff is $5 per unit ($25-$20). The quantity imported after the tariff is 425,000
units. Therefore, the total tariff revenue is: $5/unit * 425,000 units = $2,125,000
Consumer Surplus Loss:The price increase is $5.
Tariff revenue=( New import price- World price) × ( Quantity demanded+ quantity demanded after
tax)
( $25-$20)×(500,000+425,000)
=925,000/2
5×462500
Tariff revenue=$2312,500
d). The tariff generates government revenue, while the quota does not (unless licenses are auctioned).
The tariff likely results in a smaller consumer surplus loss compared to the Quota. Because the quota
restricts the supply more rigidly than the tariff, it leads to a greater increase in price and therefore a
bigger loss in consumer surplus.
(e) Four alternative measures Country Y can impose:
1. Voluntary Export Restraints (VERs): Country Y can negotiate with foreign exporters to voluntarily limit
their exports to Country Y.
2. Export subsidies: Country Y can provide subsidies to domestic exporters to encourage them to export
more.
3. Domestic content requirements: Country Y can require domestic firms to use a certain percentage of
domestic content in their products.
4. Anti-dumping duties: Country Y can impose anti-dumping duties on imports that are deemed to be
dumped in the domestic market.
Question 2
(a) Initial Price of Steel in Country C (before RTA)
World price of steel: $500 per ton
Tariff rate: 20%
Initial price in Country C = World price * (1 + Tariff rate) = $500 * (1 + 0.20) = $600 per ton
(b) New Price of Steel in Country C (after RTA)
The new price of steel in Country C for imports from Country D is the world price, which is $500 per ton.
For imports from Country E, the tariff remains at 20%, so the price is still $600 per ton.
Price of steel from Country D: $500 per ton (0% tariff)
Price of steel from Country E: $600 per ton (20% tariff)
The new price of steel in Country C will be $500 per ton. Country C will import all its steel from Country
D due to the lower price.
(c) Net Welfare Effect for Country C
To calculate the net welfare effect, we need to calculate the changes in consumer surplus, producer
surplus, government revenue, and net welfare.
Assuming the demand curve is downward-sloping, the removal of the tariff on imports from Country D
will lead to an increase in imports from Country D and a decrease in imports from Country E.
Let's assume the quantity imported from Country D increases by 50,000 tons (from 0 to 50,000) and the
quantity imported from Country E decreases by 50,000 tons (from 100,000 to 50,000).
The change in consumer surplus is the area under the demand curve and above the new price of $500,
minus the area under the demand curve and above the initial price of $600. This is a gain of $50 per ton
x 50,000 tons = $2,500,000.
The change in producer surplus is zero, since the domestic price of steel does not change.
The change in government revenue is the loss of tariff revenue from imports from Country D, which is
$100 per ton x 50,000 tons = $5,000,000. However, the government still collects tariff revenue from
imports from Country E, which is $100 per ton x 50,000 tons = $5,000,000. The net change in
government revenue is zero.
The net welfare effect is the sum of the changes in consumer surplus, producer surplus, and government
revenue, which is $2,500,000.
(d) Trade Creation and Trade Diversion
Trade Creation:The RTA with Country D leads to trade creation because Country C imports steel from a
lower-cost source (Country D) at $500 instead of $600 (importing from Country E). This increases
consumer surplus in Country C.
Trade Diversion: Import tariffs are maintained on Country E, making the steel from D more price
competitive. This diverts trade from the potentially more efficient supplier (Country E), if Country E's
production is more efficient than that of D (after accounting for distance and transport costs). This is a
negative welfare effect in Country C.
Reference:
Krugman, P. R., Obstfeld, M., & Melitz, M. J. (2012). International trade: Theory and evidence. Pearson
Education.
Mankiw, N. G. (2018). Principles of microeconomics. Cengage Learning.
Bhagwati, J. N., Panagariya, A., & Srinivasan, T. N. (2013). Lectures on international.
Rodrik, D. (2011). The globalization paradox: Democracy and the future of the world economy. W.W.
Norton & Company.
Irwin, D. A. (2011). Peddling protectionism: Smoot-Hawley and the Great Depression. Princeton
University Press.
Baldwin, R. E. (2016). The Great Trade Collapse: Causes, Consequences and Prospects. CEPR Press.
