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Lecture 8. Trade policy 2

Lecture 8. Trade policy 2 - Taris and quotas under perfect...

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Tariffs and quotas under perfect competition Optimal Tariff A large country can gain by imposing a tariff. But what level of tariff maximizes this gain? The optimal tariff . Starting from free trade, a small tariff initially increases welfare because the height and the base of the triangle ( b + d ) shrink to zero only the height of the rectangle e shrinks to zero the area of e exceeds ( b + d ) For high enough tariff, welfare will fall to its autarky level, wiping out all the gains from trade. Dasgupta (UofT) Trade Policy 18 / 54
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Tariffs and quotas under perfect competition Optimal Tariff When the tariff is low, the country still imports a lot. This allows the tariff to have a large impact on the world price. When the tariff is high, the country imports very little - it is no longer a “large” country. Dasgupta (UofT) Trade Policy 19 / 54
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Tariffs and quotas under perfect competition Optimal Tariff Optimal tariff depends on the elasticity of Foreign export supply, E * X . If the export supply curve is steep, there is little response of quantity supplied to a change in price - E * X is low. If the export supply curve is flat, the response is large - E * X is high. The optimal tariff is given by optimal tariff = 1 E * X . For a small importing country, E * X is infinite, and so the optimal tariff is zero. If E * X is small, a small reduction in quantity leads to a large reduction in price; this generates gains for the importing country. Dasgupta (UofT) Trade Policy 20 / 54
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Tariffs and quotas under perfect competition Import Quota An import quota places an upper bound on the amount of a good that can be imported. The effects on price and import quantity of applying a quota and a tariff are similar - for every level of import quota, there is an equivalent import tariff . But a quota and a tariff differ in terms of their effect on welfare; it depends on how the quota rent (area c) is distributed. Dasgupta (UofT) Trade Policy 21 / 54
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Tariffs and quotas under perfect competition Import Quota Giving the quota rent to Home firms The Home government could give quota licenses. A license allows a Home firm to purchase a pre-specified amount of the good at the world price P W and sell locally at P 2 . The net effect on Home welfare is Fall in consumer surplus: - ( a + b + c + d ) Rise in producer surplus: + a Quota rents earned at Home: + c Net effect on Home welfare - ( b + d ) Dasgupta (UofT) Trade Policy 22 / 54
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Tariffs and quotas under perfect competition Import Quota Rent seeking Firms may engage in inefficient activities to obtain quota rents.
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