Consider the following graph. Initially, the free trade price is P FT . The impo

Question

Consider the following graph. Initially, the free trade price is PFT. The importing country (you have to figure out whether this is a large country or a small country case) imposes a unit tariff equal to T = PTIM - PTEX so that the new tariff-inclusive price in the importing country is PTIM. As a result of the tariff, in the exporting country, the producer surplus falls by the area:

Select one:

a. a+b+c+d

b. e+f+g+h

c. g

d. G

e. None of the above.

Explanation / Answer

Producers surplus is the extra price that producer is getting from the sale of goods. Suppose a firm is ready to supply 10 uits of goods at $5 per unit. But it can sale them at $8. Here the firm is getting extra $3 for each unit. So producers surplus is $3 x 10 units = $30.

In the problem above exportring country was initially exporting their product at price PFT. At this price producers was ready to supply the product as show by their supply line. Note that although the country is ready to surplus much higher quantity but its product demand was much lower.

Now importing country has imposed tariff of T which will increase the import price of the product. Thus demand of imported goods will decline. Also exporter country will suffer loss of producers surpulus. Consider horizontal line PFT drawn in exporter countries diagram. It was showing the position before such change. Now this line has parallely moved below. New line is PTEX. It is reducing the area which is the summation of area e, f, g and h. Total of these areas is loss of producers surplus.

Thus correct answer is option b. i.e. e+f+g+h

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