Set06a-Tar - Econ 441 Summer Term 2003 Alan Deardorff...

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Econ 441 Alan Deardorff Summer Term 2003 Problem Set 6 - Answers Page 1 of 15 Problem Set 6 Tariffs - Answers 1. The graph below shows domestic supply and demand for a good in a small country. Suppose that it faces a world price of the good of $4 per pound. Show the effects on this market of a 25% ad valorem tariff on the good by drawing the equilibria with and without the tariff, then using the grid lines in the figure to calculate the changes in quantities supplied, demanded, and imported, and the welfare effects of the tariff on suppliers, demanders, government, and the country as a whole. Reading from the figure, quantity supplied rises from 2000 to 4000 pounds, quantity demanded falls from 9500 to 9000 pounds, quantity imported falls from 7500 to 5000 pounds. Suppliers gain area “a”, which is $3000, demanders lose area “a+b+c+d”, which is $9250, government gains revenue of area “c”, which is $5000, and the country as a whole therefore loses (9250–3000–5000) = –$1250. 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 p ($/pound) q (thousands of pounds) D S a b c d
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Alan Deardorff Summer Term 2003 Problem Set 6 - Answers Page 2 of 15 2. Use the partial equilibrium, small-country model of a tariff to work out the effects of an increase in a tariff that was already positive. For each case below, find the effects on domestic price, domestic quantities supplied and demanded, quantity of imports, and the welfare of suppliers, demanders, government, and the country as a whole. Also note, by comparing with your notes from class, whether any of these results differ from the effects of a positive tariff starting from a zero tariff. a. A tariff increase that is small enough so that the quantity of imports remains positive. Since this is a small country, the domestic price rises from p*+t to p*+t'. Supply increases from S 1 to S 2 ; demand decreases from D 1 to D 2 ; and imports decrease from M 1 to M 2 . Suppliers gain area “a”, demanders lose area “a+b+c+d” and the government’s tariff revenue changes from “e+f+g” to “c+f”, the change therefore being “+c–e–g”. This may be an increase or a decreases in revenue, depending on the sizes of these areas. If the initial and new tariffs are both not too high (below the revenue-maximizing tariff), then the tariff increase will increase revenue. Otherwise, the higher are these tariffs, the more likely it is for the revenue to fall. For the country as a whole, the net effect on welfare is a loss of “b+d+e+g”. It is the possibility of lost tariff revenue that is the main difference in these effects as compared to levying a tariff starting from zero, and also the portion of that loss, “e+g”, that is an addition to the net loss to the country, since it is a loss to government that is not a gain to anybody else. p*+t
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Set06a-Tar - Econ 441 Summer Term 2003 Alan Deardorff...

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