ECGA 6510 INTERNATIONAL TRADE

BAYBARS KARACAOVALI

PROBLEM SET 6 SOLUTIONS: TARIFF ANALYSIS

1) The import demand equation, M, is found by subtracting the home supply equation from the home demand equation. This results in Q = 80 40P [M = D S => Q = 100 20P (20 + 20P) = 100 20P 20 20P = 80 40P]. Without trade, domestic prices and quantities adjust such that import demand is zero. Thus, the price in the absence of trade is 2 (80 40P = 0 => 80 = 40P => P = 80/40 = 2). Alternatively, one can equate Homes demand and supply equations and then solve for P which would again provide the autarky price level (100 20P = 20 + 20P => 80 = 40P => P = 2.) 2) a) Foreign's export supply curve, X*, is Q = 40P 40 which is obtained by subtracting the foreign demand equation from the foreign supply equation, S* D* [X*= S* D* => Q = 40 + 20P (80 20P) = 40 + 20P 80 + 20P = 40P 40]. In the absence of trade, the price is 1. (X*= 0 => 40P 40 = 0 => 40P = 40 => P = 40/40 = 1 OR D*=S* => 80 20P = 40 + 20P => 40 = 40P => P = 40/40 = 1.) b) When trade occurs, export supply is equal to import demand, X*= M. Thus, using the equations from problems (1) and (2a), P = 1.50 (X* = M => 40P 40 = 80 40P => 80P = 120 => P = 120/80 = 1.5), and the volume of trade is 20 [plug P = 1.5 in either of X* or M equations => X* = M => Q = 40(1.5) 40 = 80 40(1.5) =20.] 3) a) The new X* curve is X*' with Q = 40(P t) 40 (it shifts horizontally to the left by $t since we measure the export supply with Q), where t is the specific tariff rate, equal to 0.5 (Intuition: The foreign producers now receive (P t) for each unit that they sell, because they have to pay $t to the home government which needs to be deducted from the sale price P.) Thus, the equation for X*' is Q = 40(P 0.5) 40 = 40P 20 40 = 40P 60. The equation for the import demand curve by the home country is unchanged. Solving, we find that the price paid by home consumers is $1.75 (X*' = M => 40P 60 = 80 40P => 80P = 140 => P = 140/80 = 1.75), and the price received by the exporter (foreign country) is equal to $1.25. [NOTE: Foreign price after tariff= PT* = PT t = 1.75 + 0.5 = $1.25.] The volume of trade has been reduced to 10 [X*' = M => Q = 40(1.75) 60 = 80 40(1.75) = 10], and the total demand for wheat at home has fallen to 65 (from the free trade level of 70) [D(PT) => Q = 100 20(1.75) = 65]. The total demand for wheat in Foreign has gone up from 50 to 55 [ D*(PT*) => Q = 80 20(1.25) = 55]. {Alternative Solution: Alternatively, interpreting the shift in X* curve to X*' as a vertical shift by $t, we can start out by re-writing the equation for X* curve in terms of Q instead of P, i.e. Q = 40P 40 => 40P = Q + 40 => P = (1/40)Q + 1. Then, the equation for X*' is P = (1/40)Q + 1 + t. Re-writing M (which is unchanged) in terms of Q as well: Q = 80 40P => 40P = 80 Q => P = 2 (1/40)Q. Now, using X*' = M, (1/40)Q + 1 + t = 2 (1/40)Q => (1/20)Q = 1 t => Q = 20 20t = 20 20(0.5) = 10. Plugging this in M => P = 2 (1/40)10 = $1.75 = PT, hence PT* = PT t = 1.75 + 0.5 = $1.25.} b), c) The welfare of the home country is best studied using the combined numerical and graphical solutions presented below.

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ECGA 6510 INTERNATIONAL TRADE

BAYBARS KARACAOVALI

Price

Home Supply

PT=1.75 PW=1.50 PT*=1.25

c e

Home Demand

50

55

65

70

Quantity

Figure 1 where the areas in the figure are: a: 55(1.75-1.50) -.5(55-50)(1.75-1.50)=13.125 b: .5(55-50)(1.75-1.50)=0.625 c: (65-55)(1.75-1.50)=2.50 d: .5(70-65)(1.75-1.50)=0.625 e: (65-55)(1.50-1.25)=2.50 Consumer surplus change: -(a+b+c+d)=-16.875. Producer surplus change: a=13.125. Government revenue (tariff revenue) change: c+e=5. Efficiency losses b+d are exceeded by terms of trade gain e. Figure 2

d)

X*`=X*+t X*
b+d

PT=$1.75 PW=$1.50 PT*=$1.25

c e

M 10 20
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ECGA 6510 INTERNATIONAL TRADE

BAYBARS KARACAOVALI

where we have used the same notation to refer to the regions that are of identical size in figures 1 and 2. Net Surplus = -b-c-d, Government Revenue = +c+e, Total Welfare=-b-d+e 4) If a good is imported into (small) country H from country F, then the imposition of a tariff for this good in country H increases the price of this good in H by the exact amount of the tariff but does not affect the price of this good in F. 5) Price of computers after tariff becomes, PT = $500 + $500 (0.10) = $550. The value added for the computer industry at world prices is, VW = $500 $100 = $400 and the value added after the tariff is, VT = $550 $100 = $450. Thus, the effective rate of protection for the domestic computer sector is, = 0.2, 1 = 0.15, 2 = 0.1, p=$800 => a1 = (300/800) = 0.375, a2 = (200/800) = 0.25=> ai i 0.2 (0.375)(0.15) (0.25)(0.1) 0.11875 0.32 ERP 1 1 0.375 0.25 0.375 ai 6) a) With free trade and no tariffs, the quantity of Widgets imported is 110 10 = 100. b) With a specific tariff of $3 per unit, the quantity of Widget imports is 80 40 = 40 c) In the absence of international trade (i.e. under autarky), The countrys consumer plus (CS): (148)(60)(1/2) = 180 The producer surplus (PS): (82)(60)(1/2) = 180 d) After the $3 specific tariff The change in consumer surplus: [After=(146)(80)(1/2)=320][Before=(143)(110)(1/2)=320]=320605=-285 The change in producer surplus: [After=(62)(40)(1/2)=][Before=(32)(10)(1/2)]=805=75 The change in government revenue: [After=(63)(8040)=][Before=0]= 1200=120 The change in total welfare: -285+75+120=-90 e) The lowest specific tariff which would be considered prohibitive is $5 (that increases the price to autarky levels). 7) a) i) Figure 8-5 (Salvatore, 2007), ii) Figure 8-6 (Salvatore, 2007) c) i) Welfare unambiguously reduced. ii) Depending on the magnitude of the terms of trade gain versus the deadweight loss from consumption and production distortions, the welfare may improve or deteriorate.

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