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NSS Exploring Economics 6

Chapter 12

International trade (II) trade barriers and external trade of Hong Kong

Questions
p.150
Think it over
1.
Why do many governments impose duties on imported goods?
2.
What are the effects of the imposition of duties on the price of imported goods, the volume of
imports, the consumer surplus of domestic consumers and the producer surplus of domestic
producers?
3.
Why does the Hong Kong Government impose duties on very few types of imports?
p.151
Discuss
12.1
Explain how the imposition of tariffs and quotas may restrict international trade and protect
domestic industries.
p.154
Discuss
12.2
Free trade benefits everybody in an economy. Do you agree? Explain.
Test yourself
12.1
Refer to Fig. 12.5. Explain why the supply curve after the imposition of a unit tariff t is
represented by the line abeg (Hint: Find out the quantities supplied at domestic prices below,
equal to and above (Pw + t), respectively).

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p.160
Discuss
12.3
Who would gain and who would lose under a quota? Fill in the following table with a ` in
the appropriate box and account for them.
Gain
The
importing
country
which
imposes a
quota

Lose

Reasons

Consumers

Producers of
import-competing
industries
The government

The
Consumers
exporting
country
Producers of
which
faces a quota exports
The government

p.167
Test yourself
12.2
How do trade barriers imposed on the exports of the mainland of China also adversely affect
Hong Kong?

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Questions and Answers to Exercises (Chapter 12)

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pp.173-176
Exercises
Multiple Choice Questions
1.
Free trade
A. benefits all domestic consumers and producers.
B. benefits domestic consumers of imports but harms domestic producers of importcompeting industries.
C. benefits domestic consumers of exports but harms domestic producers of exports.
D. harms all domestic consumers and producers.
2.
Which of the following descriptions about trade barriers is INCORRECT?
A. A tariff is a tax imposed on imports.
B. A quota is a maximum limit imposed on the quantity of imports.
C. An export subsidy is a government grant on exports.
D. Exchange control is the government control over exchange rates, i.e. the prices of
foreign currencies in terms of domestic currency.
3*.
Which of the following is an effect of a quota?
A. A quota shifts the supply curve of the imported product upwards.
B. A quota reduces both domestic consumption and domestic production.
C. A quota raises the quality of the imported product.
D A quota raises the world price of the imported product.

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4.
Refer to the following diagram. The deadweight loss brought by a tariff is represented by

A.
B.
C.
D.

Area (E + F + G).
Area (H + D + B).
Area (B + C).
Area (E + G).

6*.
Under the individual visit scheme, many individuals from the mainland of China travel to
Hong Kong. This increases Hong Kongs
(1) domestic exports of goods.
(2) re-exports of goods.
(3) exports of services.
(4) imports of goods.
A. (2) only
B. (3) only
C. (3) and (4) only
D. (1), (2) and (3) only

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8.
A.
B.
C.
D.

Which of the following descriptions about Hong Kongs attempts to face challenges in
foreign trade is INCORRECT?
Introduction of the Mandatory Provident Fund to improve the welfare of workers
Improving productivity through capital investment as well as research and development
Relocating land-intensive and labour-intensive production processes to the mainland of
China and other low-cost economies
Participating actively in international organisations and conferences to promote
international trade

Short Questions
1.
Country A imports Good X and exports Good Y.
a*. Suppose the world price of Good X is lower than the domestic price of Good X in
Country A under autarky. With the help of TWO diagrams, compare the situation
without trade and the situation with trade and show the gains from trade. Do all domestic
consumers and domestic producers benefit from trade?
(8 marks)
b**. Suppose the world price of Good Y is higher than the domestic price of Good Y in
Country A under autarky. With the help of TWO diagrams, compare the situation
without trade and the situation with trade and show the gains from trade. Do all domestic
consumers and domestic producers benefit from trade?
(8 marks)
2.
With the help of a diagram, illustrate why the imposition of a quota would benefit domestic
producers but harm domestic consumers and bring a deadweight loss to an economy.
(8 marks)
Structured Questions
1*.
In China, the import of cotton is subject to a unit tariff. After its entry into the World Trade
Organization, China has to reduce its tariff on cotton. Suppose the world price of cotton
remains unchanged after the tariff reduction.
a. With the help of a diagram, illustrate how the reduction in the tariff affects the domestic
price, domestic consumption, domestic production and volume of imports of cotton.
(7 marks)
b. How does the tariff reduction affect the consumer surplus, producer surplus, government
revenue and total social surplus?
(5 marks)

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2**.
a. Compare the effects of an increase in domestic demand on the domestic price, domestic
consumption, domestic production and volume of imports if a country imposes a tariff
and a quota on its imports, respectively.
(12 marks)
b. Would consumers prefer a tariff or a quota in the above situation?
(2 marks)

Answers
P.150
Think it over
1. They mainly want to cut the volume of imports so as to protect their domestic industries.
Moreover, imposition of duties on imported goods may raise government revenue.
2. The imposition of duties will raise the domestic price of imported goods, reduce the
volume of imports, lower the consumer surplus of domestic consumers, but
increase the producer surplus of domestic producers.
3. Many of Hong Kongs imports do not have domestic substitutes, e.g., water, food, raw
materials. Moreover, the image of a free port facilitates Hong Kong's negotiation with its
trading partners to reduce their trade barriers. On the whole, free trade brings more
benefit than harm to Hong Kong.
P.151
Discuss 12.1
After tariffs are imposed, the domestic prices of imports rise. By the law of demand, people
will buy fewer units of imports.
After the imposition of quotas, the maximum quantities of imports allowed are smaller than
the equilibrium quantities. As a result, the quantities of imports will drop.
As people buy fewer units of imports, they buy more units of domestic goods as substitutes
for imports. Hence, domestic industries are protected.

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P.154
Discuss 12.2
No.
With free trade, domestic prices drop and domestic consumption rises. As a result, the
consumer surplus increases, as illustrated by Area (C + E) in Fig. 12.3. Hence, domestic
consumers of imports gain.
However, domestic prices drop and domestic production falls. As a result, the producer
surplus decreases, as illustrated by Area C in Fig. 12.3. Hence, domestic producers of importcompeting industries lose.
Therefore, free trade does not benefit everybody. However, on the whole, as consumers gains
are greater than producers losses, the total social surplus increases, as illustrated by Area E in
Fig. 12.3.
P.154
Test Yourself 12.1
At domestic prices below (Pw + t), since the price cannot cover the cost [i.e. the world price
(Pw) plus tariff (t)], importers are not willing to supply the good. Only domestic producers
with MC domestic price will supply. This portion of the supply curve is represented by line
segment ae.
Since the domestic economy is a small open economy, it cannot affect the world price (Pw) no
matter how many units it imports. At the domestic price of (Pw + t), since the price can cover
the (constant) cost, importers are willing to supply as many units as consumers desire without
raising the price. Even if demand increases, the domestic price will not rise above (Pw + t).
Hence, the supply curve turns horizontal at Point e (represented by line segment eg).

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P.160
Discuss 12.3
Gain
The
importing
country
which
imposes a
quota

Consumers

The
exporting
country
which faces
a quota

Lose

Reasons

Higher domestic price and


lower domestic consumption

Producers of
import-competing
industries

Higher domestic price and


higher domestic production

The government

Higher tax revenue and higher


revenue from quotas if they are
auctioned off

Consumers

Lower domestic price as more


resources are turned to
domestic use

Producers of
exports

Lower output and possibly


lower output price

The government

Lower tax revenue

P.167
Test Yourself 12.2
Trade barriers imposed on the mainland of Chinas exports reduce its volume of exports. As a
result, Hong Kong, as its major entrept, also suffers from a decrease in the business of
related services, e.g., transportation, banking, warehousing, trading, etc.
pp.173-176
Exercises
Multiple Choice Questions
1. B
When the domestic price of a good under autarky is higher than its world price, the good
will be imported under free trade. The domestic price falls, domestic consumption rises
and domestic production drops. Hence, domestic consumers of imports benefit while
domestic producers of import-competing industries are harmed.
On the other hand, when the domestic price of a good under autarky is lower than its
world price, the good will be exported under free trade. The domestic price rises,
domestic consumption falls and domestic production rises. Hence, domestic consumers

NSS Exploring Economics 6


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2.

3.

4.
6.

8.

of exports are harmed while domestic producers of exports benefit.


D
Exchange control is government control over the transactions of foreign currencies by
residents or/and the transactions of domestic currencies by non-residents.
C
Option A is incorrect. After the imposition of a quota, the segment of the supply curve at
or above the world price shifts rightwards.
Option B is incorrect. A quota reduces domestic consumption but raises domestic
production.
Option D is incorrect. A quota imposed by a small open economy only raises the
domestic price. This has no effect on the world price.
D
C
Option (3) is correct. Tourists expenditures on goods and services are all counted as
exports of services.
Option (4) is also correct. Part of the goods consumed by tourists comes from imports.
As more mainland visitors travel to Hong Kong, imports of goods also increase.
A
Option A is unrelated to challenges in foreign trade.

P. 175
Short Questions
1. a.

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Since the world price of Good X (Pw) is lower than the domestic price (P0), Country A
will import Q1Q2 units of Good X. (1 mark)
Domestic consumption increases from Q0 to Q2 and the consumer surplus increases from
Area A to Area (A + C + E). Hence, domestic consumers of Good X (imports) gain.
(2 marks)
However, domestic production decreases from Q0 to Q1 and the producer surplus
decreases from Area B to Area F. Hence, domestic producers of Good X (importcompeting industries) suffer. (2 marks)
b.

Since the world price of Good Y (Pw) is higher than the domestic price (P0), Country A
will export Q1Q2 units of Good Y. (1 mark)
Domestic consumption decreases from Q0 to Q1 and the consumer surplus decreases
from Area A to Area F. Hence, domestic consumers of Good Y (exports) suffer.
(2 marks)
However, domestic production increases from Q0 to Q2 and the producer surplus
increases from Area B to Area (C + G + E + I + H). Hence, domestic producers of
Good Y (exports) gain. (2 marks)

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2.

After the imposition of a quota, the supply decreases from Sf to Sq and thus the domestic
price rises from Pw to Pq. (1 mark)
Domestic consumption drops from Q2 to Q4 and the consumer surplus decreases by
Area (I + J + K + L). Hence, domestic consumers suffer.(1 mark)
On the other hand, domestic production rises from Q1 to Q3 and the producer surplus
increases by Area I. Hence, domestic producers gain. (1 mark)
In addition, importers gain by buying imports at Pw and selling them at Pq, if they can get
the quota at zero cost. The gain is represented by Area K. (1 mark)
The change in total social surplus due to the imposition of the quota is equal to -Area (J
+ L) [= Change in consumer surplus + Change in producer surplus + Importers gain =
-Area (I + J + K +L) + Area I + Area K]. Hence, the imposition of a quota brings a
deadweight loss to an economy. (1 mark)

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P.175-176
Structured Questions
1. a.

After reducing the tariff from t1 to t2, the domestic price drops from Pt to Pt,
domestic consumption rises from Q2 to Q4, domestic production falls from Q1 to Q3
and the volume of imports rises from Q1Q2 to Q3Q4. (4 marks)

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b.

2.

Due to the fall in domestic price and the rise in domestic consumption, the
consumer surplus increases by Area (C + E + F + G). (1 mark)
Due to the fall in domestic price and the fall in domestic production, the producer
surplus decreases by Area C. (1 mark)
Government revenue changes from Area (F + K) to Area (J + K + L). (1 mark)
Hence, the change in total social surplus
= Change in consumer surplus + Change in producer surplus
+ Change in government revenue
= Area (C + E + F + G) + (-Area C) + [Area (J + K + L) Area (F + K)]
= Area (E + J + G + L) (2 marks)
Remark: Area (E + J) represents the gain to society from reducing domestic
production from Q1 to Q3. Since MCs of these units are higher than Pw, buying
imports can save costs by Area (E + J). On the other hand, Area (G + L) represents
the gain to society from raising domestic consumption from Q2 to Q4.

a.

Effects of an increase in domestic demand:


Situation with a tariff

Situation with a quota

Domestic price

Remains unchanged at Pt

Increases from Pq to Pq

Domestic consumption

Increases from Q2 to Q3
(by a larger quantity)

Increases from Q2 to Q3
(by a smaller quantity)

Domestic production

Remains unchanged at Q1

Increases from Q1 to Q4

Volume of imports

Increases from Q1Q2 to


Q1Q3

Remains unchanged
(Q1Q2 = Q4Q3)

(Each answer 1 mark, 1 mark 8 = 8 marks)

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b.

In the case of a tariff, the domestic price remains unchanged, while it increases in
the case of a quota. As a result, in the case of a tariff, the domestic consumption
increases by a larger quantity than in the case of a quota for the same increase in
demand. Hence, consumers prefer a tariff to a quota, as they have a larger consumer
surplus under a tariff than under a quota. (2 marks)

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