Economics 12th Edition Michael Parkin

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C h a p t e r
7 GLOBAL MARKETS IN
ACTION

Answers to the Review Quizzes

Page 154
1. Describe the situation in the market for a good or service that the United States imports.
The goods and services the United States will import are those in which the United States has a
higher opportunity cost of production relative to other countries. In those markets the U.S. no-
trade price is higher than the world price. With trade the quantity produced in the United States
is less than the quantity consumed and the difference is imported.
2. Describe the situation in the market for a good or service that the United States exports.
The goods and services the United States will export are those in which the United States has a
lower opportunity cost of production relative to other countries. In those markets the U.S. no-
trade price is lower than the world price. With trade the quantity produced in the United States
exceeds the quantity consumed and the excess is exported.

Page 156
1. How is the gain from imports distributed between consumers and domestic producers?
Consumers gain consumer surplus from imports and domestic producers lose producer surplus
from imports.
2. How is the gain from exports distributed between consumers and domestic producers?
Consumers lose consumer surplus from exports and domestic producers gain producer surplus
from exports.
3. Why is the net gain from international trade positive?
The net gain from international trade is positive because the gain to the winners exceeds the
losses to the losers. For instance, in the case of an imported good, all the loss of producer
surplus is transferred to consumers as consumer surplus. In addition, however, consumers also

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gain additional consumer surplus from the units imported. The total gain of consumer surplus
exceeds the loss of producer surplus so that the net surplus increases. The situation is similar for
exports: The total gain of producer surplus exceeds the loss of consumer surplus.

Page 163
1. What are the tools that a country can use to restrict international trade?
A country can use tariffs, import quotas, other import barriers such as health, safety, and
regulation barriers, and voluntary export restraints to restrict international trade. Export
subsidies given by a nation decrease other countries’ exports and thereby restrict their
international trade.

2. Explain the effects of a tariff on domestic production, the quantity bought, and the price.
A tariff raises the domestic price of the product. The higher price increases domestic production
and decreases the domestic quantity purchased.

3. Explain who gains and who loses from a tariff and why the losses exceed the gains.
Domestic consumers lose consumer surplus from the tariff. Domestic producers gain producer
surplus from the tariff. The government also gains revenue from the tariff. But the gain in
producer surplus plus the gain in government revenue is less than the loss of consumer surplus,
so on net a tariff creates a deadweight loss.

4. Explain the effects of an import quota on domestic production, consumption, and price.
An import quota raises the domestic price of the product. The higher price increases domestic
production and decreases domestic purchases.

5. Explain who gains and who loses from an import quota and why the losses exceed the
gains.
Domestic consumers lose consumer surplus from the import quota. Domestic producers gain
producer surplus from the import quota. The importers also gain additional profit from the
import quota. But the gain in producer surplus plus the importers’ profits is less than the loss of
consumer surplus, so on net an import quota creates a deadweight loss.

Page 167
1. What are the infant industry and dumping arguments for protection? Are they correct?
The attempt to stimulate the growth of new industries is the infant-industry argument for
protection, which states that it is necessary to protect a new industry from import competition
to facilitate the growth of that industry, making it competitive in the world markets. This
argument is based on the idea that as firms mature they become more productive. However this
argument for protection only works if the benefits also spill over into other industries and other
parts of the economy. This is rarely the case, as the entrepreneurs of infant industries and their
financial supporters take this risk into account and all returns usually accrue only to them, not to
other industries. And it is more efficient to subsidize the infant industry needing protection than
it is to protect it by restricting trade.
The dumping argument for protection states that a foreign firm is selling its exports at a lower
price than its cost of production. Foreign firms trying to monopolize the international market
may use this practice. Once the competition is gone, the foreign firm will raise prices and reap
profits. This argument fails for several reasons. First, it is virtually impossible to detect the
occurrence of dumping since it is impossible to verify a firm’s production costs. The test most
commonly used is if the firm’s price when it exports is lower than its domestic price. This test

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only examines the supply side of the two markets and ignores the demand side. If the domestic
market is inelastic and the export market is elastic (which is almost always the case) then it is
natural for a firm to price the domestic goods higher than the exports. Second, it is difficult to
see how a global firm could have a monopoly for the goods or services it exports. There are too
many foreign suppliers (and potential suppliers), making global competition too extensive for a
monopoly to exist in the global market. And, even if there is global monopoly it is more efficient
to regulate it than to impose trade restrictions on its products.

2. Can protection save jobs and the environment and prevent workers in developing
countries from being exploited?
There are many myths about trade restrictions. The problem mentions three of them, all false
reasons often offered as reasons to restrict international trade. These arguments are:
Trade restrictions save domestic jobs: Free international trade does, indeed, cost jobs in the
import-competing markets. But this argument ignores the fact that, under free trade,
consumers in the exporting country will have greater disposable income. These consumers
will use part of their higher income to buy goods and services from other countries, thereby
increasing employment in the exporting sector of the nation. So, although international
trade rearranges jobs—decreasing them in import-competing markets and increasing them
in exporting markets—it does not, on net, cost jobs.
Trade restrictions penalize lax environmental standards: Not all developing countries have lax
environmental standards. Also, a clean environment is a normal good. Countries that are
relatively poor and have lax pollution standards do not care as much about the environment
because imposing clean air, water, and land standards have a high opportunity cost because
they will slow economic development. The best way to encourage environmental quality is
not to restrict economic development but to encourage rapid economic growth, which will
more quickly increase citizen demand for a cleaner environment in those developing
countries.
Trade restrictions prevent rich countries from exploiting poorer countries: Importing goods
made in countries with low wage levels increases the demand for labor in those countries,
increasing the number of jobs available and raising wages over time. The more free trade
that occurs with these countries, the more quickly the wages will rise and the working
conditions will increase in quality and safety.

3. What is offshore outsourcing? Who benefits from it and who loses?

Offshore outsourcing occurs when a firm in the United States buys finished goods, components,
or services from firms in other countries. Workers who have skills for jobs that have been sent
abroad lose from offshore outsourcing. Consumers who consume the goods and services
produced abroad and imported into the United States benefit.

4. What are the main reasons for imposing a tariff?

There are two main reasons for imposing tariffs on imports. First the government receives tariff
revenues from imports, which can be useful when revenues from income taxes and sales taxes
are less effective ways of gaining government revenue. Second rent seeking by individuals in
industries that would be hurt by foreign competition can influence the government to impose
tariffs.

5. Why don’t the winners from free trade win the political argument?
Trade restrictions are enacted despite the inherent inefficiency because of the political actions of
rent seeking groups, which fear that foreign competition might have a negative impact on their
industry, firm, or jobs. The anti-trade groups are easily organized and have much to gain from

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trade restrictions, whereas the vast millions of consumers, who would win from free trade, are
difficult to organize because each individual has only a small amount of loss when trade
restrictions are imposed. Hence the winners from trade restrictions frequently out-lobby the
winners from free trade.

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Answers to the Study Plan Problems and Applications

Use the following data to work Problems 1 to
Price Quantity Quantity
3.
(dollars per demanded supplied
Wholesalers buy and sell roses in containers
container) (millions of containers per
that hold 120 stems. The table provides
year)
information about the wholesale market for
100 15 0
roses in the United States. The demand
125 12 2
schedule is the wholesalers’ demand and the
150 9 4
supply schedule is the U.S. rose growers’
175 6 6
supply. Wholesalers can buy roses at auction
200 3 8
in Aalsmeer, Holland, for $125 per container.
225 0 10
1. a. Without international trade, what
would be the price of a container of roses and how many containers of roses a year
would be bought and sold in the United States?
Without international trade, in the United States the price of a container of roses is $175 and 6
million containers of roses are bought and sold.
b. At the price in your answer to part (a), does the United States or the rest of the world
have a comparative advantage in producing roses?
The price of roses in the United States exceeds the price in the rest of the world, so the rest of
the world has a comparative advantage in producing roses.
2. If U.S. wholesalers buy roses at the lowest possible price, how many do they buy from U.S.
growers and how many do they import?
The price of roses in the United States is $125 per container. At this price, U.S. rose growers
supply 2 million containers per year and U.S. wholesalers demand 12 million containers of roses.
U.S. wholesalers buy the 2 million containers from U.S. growers and purchase 10 million
containers from foreign sources, which are imported into the United States.
3. Draw a graph to illustrate the U.S. wholesale market for roses. Show the equilibrium in that
market with no international trade and the
equilibrium with free trade. Mark the
quantity of roses produced in the United
States, the quantity imported, and the total
quantity bought.
In Figure 7.1, the equilibrium without
international trade is determined at the
intersection of the demand curve and the
supply curve. Without international trade the
equilibrium price is $175 per container and 6
million containers per year are bought and
produced. With international trade the world
price is $125 per container, as shown in Figure
7.1. The quantity produced in the United
States is 2 million containers and the quantity
bought in the United States is 12 million
containers. Imports into the United States

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account for the difference between the quantity bought and the quantity produced, 10 million
containers.
4. Use the information on the U.S. wholesale market for roses in Problem 1 to
a. Explain who gains and who loses from free international trade in roses compared to a
situation in which Americans buy only roses grown in the United States.
U.S. rose wholesalers, who are the consumers in the problem, gain from free international trade.
U.S. rose growers lose from free international
trade.
b. Draw a graph to illustrate the gains and
losses from free trade.
Figure 7.2 illustrates the market with free trade.
Consumer surplus before international trade is
equal to area A; after international trade
consumer surplus is equal to area A + area B +
area C. Producer surplus before international
trade is equal to area B + area D; after
international trade producer surplus is equal to
area D.
c. Calculate the gain from international trade.
The gain from international trade is area C in
Figure 7.2. It is equal to ½  ($175  $125)  (10
million containers) which is $250 million.

Use the information on the U.S. wholesale market for roses in Problem 1 to work Problems 5 to
10.
5. If the United States puts a tariff of $25 per container on imports of roses, explain how the
U.S. price of roses, the quantity of roses bought, the quantity produced in the United
States, and the quantity imported changed.
The U.S. price of roses rises from $125 per container (the price with free trade) to $150 per
container. The quantity of roses produced in the United States increases from 2 million
containers (the quantity produced with free trade) to 4 million containers. The quantity of roses
consumed in the United States decreases from 12 million containers (the quantity consumed
with free trade) to 9 million containers. The quantity imported decreases from 10 million
containers to 5 million containers.
6. Who gains and who loses from this tariff?
U.S. rose consumers lose from the tariff. U.S. rose producers gain from the tariff. The U.S.
government gains revenue from the tariff.

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7. Draw a graph of the U.S. market for roses to

illustrate the gains and losses from the tariff
and on the graph identify the gains and
losses, the tariff revenue, and the deadweight
loss created.
Figure 7.3 shows the effect of the tariff. The
amount of the tariff per container is equal to
the height of the light gray arrow. Before the
tariff U.S. consumer surplus was equal to area
A + area B + area C + area E + area F. After
the tariff U.S. consumer surplus is equal to
area A. U.S. consumers lose consumer surplus
equal to area B + area C + area E + area F.
Before the tariff U.S. producer surplus was
equal to area G. After the tariff U.S. producer
surplus is equal to area G + area B. U.S.
producers gain producer surplus equal to area
B. After the tariff the U.S. government gains tariff revenue equal to area E. The deadweight loss
from the tariff is equal to area C + area F.
8. If the United States puts an import quota on roses of 5 million containers, what happens
to the U.S. price of roses, the quantity of roses bought, the quantity produced in the
United States, and the quantity imported?
The U.S. price of roses rises to $150 per container. 9 million containers of roses are purchased in
the United States and 4 million containers of roses are produced in the United States. The
difference, 5 million containers, is imported into the United States.
9. Who gains and who loses from this quota?
U.S. rose growers and importers of roses gain from the quota. U.S. rose wholesalers lose from
the quota.
10. Draw a graph to illustrate the gains and
losses from the import quota and on the
graph identify the gains and losses, the
importers’ profit, and the deadweight loss.
Figure 7.4 shows the effect of the import
quota. The amount of the quota is equal to
the length of the gray arrow. Before the
quota U.S. consumer surplus was equal to
area A + area B + area C + area E + area F.
After the quota U.S. consumer surplus is
equal to area A. U.S. consumers lose
consumer surplus equal to area B + area C +
area E + area F. Before the quota U.S.
producer surplus was equal to area G. After
the quota U.S. producer surplus is equal to
area G + area B. U.S. producers gain producer
surplus equal to area B. After the quota the

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importers of the rose containers earn profit equal to area E. The deadweight loss from the
import quota is equal to area C + area F.

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11. Chinese Tire Maker Rejects Charge of Defects

U.S. regulators ordered the recall of more than 450,000 faulty tires. The Chinese producer
of the tires disputed the allegations and hinted that the recall might be an effort to
hamper Chinese exports to the United States.
Source: International Herald Tribune, June 26, 2007
a. What does the news clip imply about the comparative advantage of producing tires in
the United States and China?
Because the tires were produced in China, the news clip suggests that China has the
comparative advantage in producing tires.
b. Could product quality be a valid argument against free trade? If it could, explain how.
Product quality is not a valid argument against free trade. Quality is a valid concern for
consumers. If consumers cannot judge quality themselves, then government inspection might
be necessary. But in that case government inspection of both imported and domestically
produced goods is required. To single out imported goods or services makes little sense. And,
by questioning the quality of tires, U.S. producers create questions in the minds of U.S.
consumers regarding the safety of imported tires, thereby increasing the demand for
domestically produced tires.

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Answers to Additional Problems and Applications

12. Suppose that the world price of sugar is 10 cents a pound, the United States does not
trade internationally, and the equilibrium price of sugar in the United States is 20 cents a
pound. The United States then begins to trade internationally.
a. How does the price of sugar in the United States change?
The price of sugar in the United States falls.
b. Do U.S. consumers buy more or less sugar?
As a result of the lower price, U.S. consumers buy more sugar.
c. Do U.S. sugar growers produce more or less sugar?
As a result of the lower price, U.S. growers produce less sugar.
d. Does the United States export or import sugar and why?
The United States imports sugar. The quantity of sugar demanded increases while quantity
supplied decreases. The difference is made up by imports.
13. Suppose that the world price of steel is $100 a ton, India does not trade internationally,
and the equilibrium price of steel in India is $60 a ton. India then begins to trade
internationally.
a. How does the price of steel in India change?
The price of steel in India rises to equal the world price.
b. How does the quantity of steel produced in India change?
Producers respond to the higher price by increasing the quantity of steel produced.
c. How does the quantity of steel bought by India change?
Steel users in India respond to the higher price by decreasing the quantity of steel bought.
d. Does India export or import steel and why?
Because the price of steel in India is lower than the world, India has a comparative advantage in
the production of steel. India will export steel.
14. A semiconductor is a key component in
Price Quantity Quantity
your laptop, cell phone, and iPod. The
(dollars per demanded supplied
table provides information about the
unit) (billions of units per year)
market for semiconductors in the United
10 25 0
States. Producers of semiconductors can
12 20 20
get $18 a unit on the world market.
14 15 40
a. With no international trade, what would
16 10 60
be the price of a semiconductor and how
18 5 80
many semiconductors a year would be
20 0 100
bought and sold in the United States?
With no international trade the price of a semiconductor in the United States is $12 per unit. 20
billion units are bought and sold in the United States.
b. Does the United States have a comparative advantage in producing semiconductors?
The United States has a comparative advantage in producing semiconductors because the U.S.
price is lower than the price in the world market.
15. Act Now, Eat Later
The hunger crisis in poor countries has its roots in U.S. and European policies of

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subsidizing the diversion of food crops to produce biofuels like corn-based ethanol. That
is, doling out subsidies to put the world’s dinner into the gas tank.
Source: Time, May 5, 2008
a. What is the effect on the world price of corn of the increased use of corn to produce
ethanol in the United States and Europe?
The use of corn to produce ethanol increased the demand for corn, thereby raising the price of
corn.
b. How does the change in the world price of corn affect the quantity of corn produced in a
poor developing country with a comparative advantage in producing corn, the quantity
it consumes, and the quantity that it either exports or imports?
The higher world price of corn decreases the consumption of corn and increases the production
of corn in poor developing countries. Because the country has a comparative advantage it will
export corn. The higher price leads the country to increase its exports.
16. Draw a graph of the market for corn in the
poor developing country in Problem 15(b) to
show the changes in consumer surplus,
producer surplus, and deadweight loss.
Figure 7.5 shows the situation in the poor
country that exports corn. With the initial lower
price, the country produces 60 million bushels,
exports 20 million bushels, and consumes 40
million bushels. The consumer surplus is equal
to area A + area B and the producer surplus is
equal to area E. After the world price of corn
rises to $8 per bushel, the country produces 80
million bushels of corn, exports 60 million
bushels, and consumes 20 million bushels.
Consumer surplus decreases to area A and
producer surplus increases to area B + area C +
area E. There is no deadweight loss; in fact, the
country gains additional surplus equal to area C.

Use the following news clip to work Problems 17 and 18.

South Korea to Resume U.S. Beef Imports
South Korea will reopen its market to most U.S. beef. South Korea banned imports of U.S. beef
in 2003 amid concerns over a case of mad cow disease in the United States. The ban closed
what was then the third-largest market for U.S. beef exporters.
Source: CNN, May 29, 2008
17. a. Explain how South Korea’s import ban on U.S. beef affected beef producers and
consumers in South Korea.
The South Korean ban raised the price of beef in South Korea. The higher price led to increased
production in South Korea, which made South Korean producers better off. The higher price
also led to decreased consumption in South Korea, which made South Korean consumers worse
off.

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b. Draw a graph of the market for beef in South Korea to illustrate your answer to part (a).
Identify the changes in consumer surplus, producer surplus, and deadweight loss.
Figure 7.6 shows the effect of South Korea’s
import ban. Prior to the ban the price of beef
in South Korea was $4 per pound. At this
price the quantity consumed in South Korea
was 12 million tons of beef per year and the
quantity produced in South Korea was 2
million tons of beef per year. The difference,
10 million tons of beef per year, was imported
from the United States. Consumer surplus in
South Korea was equal to area A + area B +
area C and producer surplus in South Korea
was equal to area E. With the import ban, the
price of beef in South Korea rises to $6 per
pound. At this price 6 million tons of beef per
year are consumed in South Korea and 6
million tons of beef per year are produced in
South Korea. There are no imports. Consumer
surplus is South Korea shrinks to only area A
and producer surplus grows to equal area B + area E. There is now a deadweight loss which is
equal to area C.
18. a. Assuming that South Korea is the only importer of U.S. beef, explain how South Korea’s
import ban on U.S. beef affected beef producers and consumers in the United States.
South Korea’s ban meant that the United States no longer exported beef. (Recall the assumption
that South Korea is the only importer of U.S. beef.) In the United States the price of beef falls to
the no-trade price. U.S. consumption increases and U.S. production decreases so U.S. consumers
are better off and U.S. producers are worse
off.
b. Draw a graph of the market for beef in the
United States to illustrate your answer to
part (a). Identify the changes in consumer
surplus, producer surplus, and deadweight
loss.
Figure 7.7 shows the situation in the U.S.
market for beef. With trade the price of beef
is $4 per pound. The United States produces
30 million pounds of beef, consumes 20
million pounds of beef, and exports the
difference. At this price consumer surplus in
the United States is equal to area A and
producer surplus is equal to area B + area C +
area E. When South Korea eliminates U.S.
exports, the price falls to $3.50 per pound, the
no-trade price. U.S. consumer surplus increases from area A to area A + area B. U.S. producer
surplus falls from area B + area C + area E to only area E. The deadweight loss equals area C.

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Use the following information to work Problems 19 to 21.

Before 1995, trade between the United States and Mexico was subject to tariffs. In 1995, Mexico
joined NAFTA and all U.S. and Mexican tariffs have gradually been removed.
19. Explain how the price that U.S. consumers pay for goods from Mexico and the quantity of
U.S. imports from Mexico have changed. Who are the winners and who are the losers from
this free trade?
With NAFTA, the prices that U.S. consumers pay for goods from Mexico have fallen and, as a
result, the quantity of imports from Mexico have increased. Winners from this free trade are
Mexican producers of goods exported to the United States and U.S. consumers of these goods.
Losers are Mexican consumers of the goods and U.S. producers of the goods.
20. Explain how the quantity of U.S. exports to Mexico and the U.S. government’s tariff
revenue from trade with Mexico have changed.
The prices of U.S. goods in Mexico have fallen and, as a result, the quantity of U.S. goods
exported to Mexico has increased. The U.S. government’s tariff revenue from tariffs imposed on
trade with Mexico decreased.
21. Suppose that in 2015 tomato growers in Florida lobby the U.S. government to impose an
import quota on Mexican tomatoes. Explain who in the United States would gain and who
would lose from such a quota.
U.S. tomato growers gain from such a quota. The importers who hold the quota rights also gain.
U.S. consumers of tomatoes lose from such a quota.
Use the following information to work Problems 22 and 23.
Suppose that in response to huge job losses in the U.S. textile industry, Congress imposes a 100
percent tariff on imports of textiles from China.
22. Explain how the tariff on textiles will change the price that U.S. buyers pay for textiles, the
quantity of textiles imported, and the quantity of textiles produced in the United States.
The tariff raises the U.S. price of textiles. As a result, the quantity of textiles consumed in the
United States decreases and the quantity produced increases. Imports of textiles into the United
States decrease.
23. Explain how the U.S. and Chinese gains from trade will change. Who in the United States
will lose and who will gain?
The decrease in trade means that the U.S. and Chinese gains from trade decrease. In the United
States, U.S. producers gain from the tariff. The U.S. government also gains revenue from the
tariff. U.S. textile consumers lose.
Use the following information to work Problems 24 and 25.
With free trade between Australia and the United States, Australia would export beef to the
United States. But the United States imposes an import quota on Australian beef.
24. Explain how this quota influences the price that U.S. consumers pay for beef, the quantity
of beef produced in the United States, and the U.S. and the Australian gains from trade.
The quota raises the price of beef in the United States. By raising the U.S. price, the quota
increases the quantity of beef produced in the United States and decreases the quantity of beef
consumed in the United States. The U.S. and Australian gains from trade decrease.

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25. Explain who in the United States gains from the quota on beef imports and who loses.
U.S. beef producers gain from the quota. The people who hold the import quota rights also
gain. U.S. beef consumers lose from the quota.

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26. Trading Up
The cost of protecting jobs in uncompetitive sectors through tariffs is high: Saving a job in
the sugar industry costs American consumers $826,000 in higher prices a year; saving a
dairy industry job costs $685,000 per year; and saving a job in the manufacturing of
women’s handbags costs $263,000.
Source: The New York Times, June 26, 2006
a. What are the arguments for saving the jobs mentioned in this news clip? Explain why
these arguments are faulty.
The arguments for saving these jobs are (explicitly) the argument that protection saves jobs and
(implicitly) that protection allows us to compete with cheap foreign labor.
The fact these arguments are wrong can be demonstrated by comparing the cost of saving a job
to the wage paid on the job. The cost to U.S. consumers of saving a job massively outweighs the
benefit of a job to the worker, that is, the wage rate paid on the job. This empirical result
demonstrates the conclusion that the cost of protection to the losers, U.S. consumers, exceeds
the gain to the winners, U.S. producers.
b. Is there any merit to saving these jobs?
There is merit to the workers whose jobs are saved and who might not receive any government
assistance if their jobs are not protected. There also is merit to the politicians who can obtain a
reward from lobbyists for the protection. There is no merit, however, to society as a whole.

Economics in the News

27. After you have studied Economics in the News on pp. 168–169, answer the following
questions.
a. What is the TPP?
The TTP is the Trans Pacific Partnership, a trade agreement among 12 nations.
b. Who in the United States would benefit and who would lose from a successful TPP?
U.S. exporters of goods whose tariffs are reduced and U.S. consumers of imported goods whose
tariffs are reduced benefit from a successful TPP. U.S. consumers of exported goods whose
tariffs are reduced and U.S. producers of imported goods whose tariffs are reduced lose from a
successful TPP. The government might gain or lose tariff revenue depending on the magnitudes
of the consumption and production changes.
c. Illustrate your answer to part (b) with an appropriate graphical analysis assuming that
tariffs are not completely eliminated.
Figure 7.8a (on the next page) shows the effect in the United States of lowering the U.S. tariff on
a good. Initially the price in the United States was $90 per unit. Consumer surplus was equal to
area A and producer surplus was equal to area B + area F. When the tariff is lowered, the price
in the United States becomes $70 per unit. Consumer surplus increases and equals area A + area
B + area C. Producer surplus, however, decreases to area F. The government’s tariff revenue
equals area E.
Figure 7.8b (on the next page) shows the effect in the United States of lowering the Japanese
tariff on rice. Initially the price in the United States was $300 per ton. Consumer surplus was
equal to area A + area B and producer surplus was equal to area E. When the tariff is lowered so
that the Japanese now import rice, the price in the United States rises to become the world price
of $500 per ton. Consumer surplus decreases and equals area A. Producer surplus, however,
increases to area B + area C + area E.

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d. Who in Japan and other TPP nations would benefit and who would lose from a
successful TPP?
In other TPP nations and particularly in Japan, consumers of rice and other farm products would
benefit from a successful TPP. In other TPP nations and particularly in Japan, producers of rice
and other farm products would lose from a successful TPP. The Japanese government would
lose tariff revenue.
e. Illustrate with an appropriate graphical analysis who in Japan would benefit and who
would lose from a successful TPP assuming that all Japan's import quotas and tariffs are
completely eliminated.
Figure 7.9 shows the effect in Japan of
eliminating Japan’s tariffs and import
quotas. Figure 7.9 shows the effect in the
market for rice; the effect in other markets is
similar. Before the tariffs and import quotas
are eliminated, the price in Japan was $700
per ton of rice. The consumer surplus is
equal to area A, the producer surplus was
equal to area B + area C and the
government’s tariff revenue (and/or
importers’ economic profit) was equal to
area E. After the tariffs and import quotas
are removed, the price falls to $500 per ton
of rice. Consumer surplus increases and
equals area A + area B + area F + area E +
area G. Producer surplus, however,
decreases to area C. The government’s tariff revenue (and/or importers’ economic profit)
disappears. Consumers benefit because their consumer surplus increases; producers lose
because their producer surplus decreases; the government (and/or importers) loses because
their tariff revenue (or economic profit) is eliminated.

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 GOVERNMENT ACTIONS IN MARKETS 105

28. E.U. Agrees to Trade Deal with South Korea

Italy has dropped its resistance to a E.U. trade agreement with South Korea, which will
wipe out $2 billion in annual duties on E.U. exports. Italians argued that the agreement,
which eliminates E.U. duties on South Korean cars, would put undue pressure on its own
automakers.
Source: The Financial Times, September 16, 2010
a. What is a free trade agreement? What is its aim?
A free trade agreement is an agreement among nations that they will not impose tariffs, quotas,
or other protectionist policies on each other’s imports.
b. Explain how a tariff on E.U. car imports
changes E.U. production of cars, purchases
of cars, and imports of cars. Illustrate your
answer with an appropriate graphical
analysis.
The tariff that was imposed by the European
Union decreased E.U. imports of cars. It
raised the price of cars in the European
Union, thereby increasing production of cars
in the European Union and decreasing
purchases of cars in the European Union. In
Figure 7.10, the world price is $20,000 per
car and the E.U. tariff is $2,500 per car. The
price in the European Union is $22,500 per
car. The quantity produced in the European
Union is 20,000 cars per year and the
quantity purchased is 42,333 per year so that
22,333 cars per year are imported. If there was no tariff, so that the price in the European Union
was equal to the world price, the quantity produced in the European Union would be 10,000
and the quantity purchased would be 60,000 so that 50,000 cars per year are imported.
c. Show on your graph the changes in
consumer surplus and producer surplus
that result from free trade in cars.
Figure 7.11 shows how the consumer surplus
and producer surplus change if the E.U. tariff
is eliminated. With the tariff in place, the
consumer surplus equals area A and the
producer surplus equals area B + area E. If
the tariff is eliminated, the price in the
European Union falls to $20,000 per car.
Consumer surplus increases the area A +
area B + area C. Producer surplus decreases
to area E.
d. Explain why Italian automakers opposed
cuts in car import tariffs.
Italian automakers opposed cuts in the tariff
because they knew that if the tariff was cut,

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106 CHAPTER 7

the price of cars in Italy would fall, thereby decreasing their producer surplus.

© 2016 Pearson Education, Inc.