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Principles of Economics- Mankiw (5th) 183

Principles of Economics- Mankiw (5th) 183 - CHAPTER 9 A P P...

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CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 189 It is not surprising that a tariff causes a deadweight loss, because a tariff is a type of tax. Like any tax on the sale of a good, it distorts incentives and pushes the allocation of scarce resources away from the optimum. In this case, we can identify two effects. First, the tariff on steel raises the price of steel that domestic producers can charge above the world price and, as a result, encourages them to increase pro- duction of steel (from Q 1 S to Q 2 S ). Second, the tariff raises the price that domestic steel buyers have to pay and, therefore, encourages them to reduce consumption of steel (from Q 1 D to Q 2 D ). Area D represents the deadweight loss from the overpro- duction of steel, and area F represents the deadweight loss from the undercon- sumption. The total deadweight loss of the tariff is the sum of these two triangles. THE EFFECTS OF AN IMPORT QUOTA The Isolandian economists next consider the effects of an import quota —a limit on the quantity of imports. In particular, imagine that the Isolandian government dis-
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