o Like most taxes, it distorts incentives and pushes the allocation of scarce resources away from the optimum o In this case, we can identify 2 effects When the tariff raises the domestic price of textiles above the world price, it encourages domestic producers to increase production from Q S 1 to Q S 2 Even though the cost of making these incremental units exceeds the cost of buying them at the world price, the tariff makes it profitable for domestic producers to manufacture them nonetheless When the tariff raises the price that domestic textile consumers have to pay, it encourages them to reduce consumption of textiles from Q D 1 to Q D 2 Even though domestic consumers value these incremental units at more than world price, the tariff induces them to cut back their purchases o Area D represents the deadweight loss from the overproduction of textiles, and area F represents the deadweight loss from the underconsumption of textiles The total deadweight loss of the tariff is the sum of these two triangles Figure 4 A tariff reduces the quantity of imports and moves a market closer to the equilibrium that would exist without trade. Total surplus falls by an amount equal to area D + F. These two triangles represent the deadweight loss from the tariff.
9-2d The Lessons for Trade Policy Answers to the previous 3 questions about opening up trade from section 9-1a Q – If the gov't allows Isolandians to import and export textiles, what will happen to the price of textiles and the quantity of textiles sold in the domestic textile market? A – Once trade is allowed, the Isolandian price of textiles will be driven to equal the price prevailing around the world o If the world price is now higher than the Isolandian price, the Isolandian price will rise The higher price will reduce the amount of textiles Isolandians consume and raise the amount of textiles that Isolandians produce Isoland will, therefore, become a textile exporter This occurs because, in this case, Isoland has a comparative advantage in producing textiles o Conversely, if the world price is now lower than the Isolandian price, the Isolandian price will fall The lower price will raise the amount of textiles that Isolandians consume and lower the amount of textiles that Isolandians produce Isoland will, therefore, become a textile importer
This occurs because, in this case, other countries have a comparative advantage in producing textiles Q – Who will gain from free trade in textiles and who will lose, and will the gains exceed the losses? A – Answer depends on whether the price rises or falls when trade is allowed o If the price rises, producers of textiles gain, and consumers of textiles lose o If the price falls, consumers gain, and producers lose In both cases, the gains are larger than the losses Thus, free trade raises the total welfare of Isolandians Q – Should a tariff be part of the new trade policy?