For the following questions, refer to the figure below: Suppose the figure above

Question

For the following questions, refer to the figure below:

Suppose the figure above represents the US market for product X (the horizontal axis in the figure shows the quantity of product X demanded and supplied in the US market) .

i) What is the price of X under free trade? In the figure above, the US has imposed a tariff (denoted by t) of what size? Is the US a small or a large country in the market for product X?

ii) What happens to the quantity of imports of X to the US as the tariff is imposed (how much do the import increase or decrease)? Is the world price of X affected?

iii) Who gains and who loses from the tariff in the US? Give the size of the gains and losses as accurately as possible.

Is the US better off or worse off as a consequence of the tariff (consider the net effect on the economy)? Explain.

iv) Considering the impact of the tariff on the US economy, why might the tariff be imposed in the first place?

v) Are there any alternative policies that could be used to attain the goals of part iv)? Are these policies more or less costly for the US economy (in terms of the deadweight loss created by the policy)? Explain.

Explanation / Answer

i. Under free trade price of x is denoted by pw in the graph which is equal to $16. As can be seen from the graph, the price line has shifted above to $22. Thus, US has imposed tariff of $22- $16 = $6. US is a small country in the market fro X as the graph depicts small country case.

ii. At price of X = $16, the imports of good X were 26-10 = 16 units given by the excess demand at price $16.

With the imposition of tariff, the excess demand of the good has fallen to 22- 14 = 8 units. Thus, imports decline by 16 - 8 = 8 units.

Since this is a small country case, so the world price of X is not affected.

iii. Government will gain revenue from imposition of tariff. Consumer surplus will decline and producer surplus will increase due to increase in the prices.Overall the country will lose.

The deadweight loss associated with the imposition of tariff = Production component = 1/2 * (22-16) * ( 14 - 10 ) = $12, Consumption component = 1/2 * (22- 16) * ( 26 - 22) = 1/2 * 6 * 4 = $12. Thus deadweight loss = $24.

Thus, US is worse off after imposing tariff.

iv. It is imposed in the first place to control the growing imports, to protect the infant industry from competition from abroad.

v. Restricting trade has not been desirable for any economy.rather than relying on tariff and non tariff measures like quotas etc, the countries should make themselves more efficient using technology. In initial phase, infant industry argument or protecting infants is considered but ultimately it should be given up to make industries competitive.

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