CAP 9

Questão 1

Home import demand is the excess of demand of Home consumers over the
supply of Home producers. So, Home import demand (MD) equation is obtained
by the subtraction of Home producers supply (S) from home consumers demand
(D).

MD = D - S = (100 – 20 P) – (20+20P) = 100 -20P – 20 – 20P = 80 -40P ...... (1)

In the absence of trade, domestic demand and domestic supply equals each
other such that import demand is zero. Thus, the price of wheat in the Home
country in the absence of trade is

M D = 80 – 40P

0 = 80 – 40

40P = 80

If the price of wheat increases, Home consumers demand less, but Home
producers supply more, so, import demand declines. This inverse relationship
between the price of the good and its demand for imports when depicted
graphically gives rise to a downward sloping import demand curve which is show
in the diagram below:

Import Demand Curve At price 2 the MD curve intercepts the price axis
(import demand = 0 at price 2)
Questão 2 -> Sem solução.

Questão 3

a) In the absence of tariff, the price of wheat is 1.5 in both Home and Foreign.

Given:

• Home’s demand curve for wheat is:

• Home’s supply curve for wheat is:

• Foreign demand curve for wheat:

• Foreign supply curve for wheat is:

With the imposition of tariff of 0.5 by the Home country, shippers will be unwilling
to move the wheat from Foreign to Home unless the Home price exceeds the
foreign price by at least the tariff rate of 0.5.

However, there will be an excess demand for wheat in Home and an excess
supply in Foreign, if there is no shipping of wheat.

Thus, the price in Home will rise and that in Foreign will fall until the price
difference is 0.5.

Therefore, a tariff drives a wedge between the prices in the two markets.

The equation for new MD curve is

Where:

• P is the price, equal to 1.5, and

• t is the tariff rate, equal to 0.5.

The equation for new XS curve is

The equation for the export supply curve by the foreign country is unchanged.
Setting the import demand (MD) equal to export supply (XS) we solve the value
of P as:

Therefore, the price of wheat in foreign country is 1.25.

Now, adding the new price with the tariff rate gives us the domestic price as:

Therefore, the domestic price is 1.75.

Thus, to summarize:

• The world price is 1.25

• The price in home country is 1.75

• The price in foreign country is 1.25

Given:

Home’s demand curve for wheat is:

Home’s supply curve for wheat is:

Now, substitute the above-calculated prices in the equations for demand and
supply to get the demand and supply for Home and Foreign.

Accordingly,
Similarly,

Now, calculate the volume of trade by the equation for MD or XS:

Therefore, the volume of trade is 10.

The diagram below shows the effect of tariff on the trade market:

In the above diagram, the intersection of MD curve and XS curve determine the
world price for wheat at 1.5.

With the imposition of tariff, the MD curve shifts to MD1.

After tariff, the home price increases to1.75 while the foreign price falls to 1.25 so
that the difference between the two is equal to the amount of tariff. In Home,
imports will be fewer as producers supply more at a higher price, while consumers
demand less. In Foreign, lower price leads to reduced supply and increased
demand. Thus, export supply is smaller and the volume of wheat traded declines
from 20 to 10.

b) (1) Home import-competing producers are better off because they get higher
prices for their goods and that induces them to increase the supply of wheat.
Moreover, they have less competition from the foreign producers. (2) Home
consumers are worse off because they have to pay a higher price for wheat. (3)
The Home government benefits because now they have additional tariff revenue.

c) The following diagram shows the terms of trade gain, the efficiency loss, and
the total effect on welfare of the tariff:

Effect of Tariff on the Trade Gain, Efficiency Loss & Welfare

The cost and benefits of a tariff for the importing country is shown by the five
area a, b, c, d and e. Let us first calculate the values for the following areas:
Note: In the calculation of area a, b, and c which are triangles, the formula

is .

As a tariff lowers foreign export price, trade gains arise. Rectangle e in the above
diagram represents the trade gain.

In the above diagram, triangles b + d represent the efficiency loss that arises
because of tariff distorts.

The welfare effect of tariff on the three players of the economy is as follows:

Questão 4

The export supply for the large Foreign country is given by:

XS = S* - D* = 400 + 200P – (800 – 200P) = −400 + 400P.

The import demand for the Home country remains the same:

MD = 80 – 40P

Therefore the free trade equilibrium is given by:

MD (P) = XS (P) 80 − 40P = −400 + 400P80 + 400 = 400P + 40 P 480 = 440P P =
1.09

Now, the volume of trade = 80 – 40 (1.09) = 36.40After the tariff imposition of 0.5
by the Home country, the new equilibrium is given as:

MD (P +0. 5) = XS (P) 60 − 40P = −400 + 400P 60 + 400 = 400P + 40P P = 1.045

= 1.05

Now, adding the new price with the tariff rate gives us the domestic price of Home
as:

P = 1.05 + 0.5

= 1.55

The quantity demanded and supplied in Home and Foreign is calculated as

Quantity demanded in Home = 100 – 20 × 1.55

Quantity supplied in Home = 20 + 20 × 1.55

Similarly Quantity demanded in Foreign = 800 – 200 × 1.05

Quantity of wheat supplied in Foreign = 400 + 200 × 1.05

= Now, the volume of trade is given by the equation for MD or XS:

Volume of trade = 80 – 40 (1.55) = 18

When Home is relatively small, the effect of a tariff on world price is smaller than
when Home and Foreign are closer in size. When Foreign and Home were closer
in size, a tariff of .5 by home lowered world price by 25 percent, whereas in this
case the same tariff lowers world price by about 5 percent.

In this case, the terms of trade gain, the efficiency loss, and the total effect on
welfare of the tariff is explained below:

The government revenues from the tariff = 9.10

The loss in consumer surplus = -33.51

The producer surplus gain = 21.089.

The terms of trade gains = 0.819

The efficiency loss = 4.14

It should be noticed that the efficiency loss is more than the terms of trade gain
indicating that a small country losses more from tariff.

Questão 5

The effective rate of protection in any industry refers to the percentage effect of
the entire tariff structure on the value added per unit of output in that industry,
when both intermediate and final goods are imported.

Write the formula for calculating effective rate of protection as follows:

Where,

Value added in the presence of trade policies is represented by VT.

Value added in the industry at world prices is represented by VW.

Given, the world price of bicycle = $200

The world price of bike component = $100

Calculate the value added of the bicycle at world price (VW) as follows:

Thus, the value added of the bicycle at world price (VW) is .

Given that the tariff on bicycles is 50%.

Calculate the world price of bicycle after tariffs as follows:

Thus, the value of world price of bicycles after tariffs is .

Calculate the value added of the bicycle in the presence of tariff (VT) as follows:

Thus, the value of VT is .

Calculate the effective rate of protection on bicycle in China as follows:

Substitute the value for VT and Vw in the formula.

Thus, the effective rate of protection on bicycle is

Questão 6

The effective rate of protection in any industry refers to the percentage effect of
the entire tariff structure on the value added per unit of output in that industry,
when both intermediate and final goods are imported. Therefore, it takes into
account the cost of the intermediate good that is corn. Corn accounts for 55% of
the cost of production of ethanol in United States.

The value added in the industry at world prices = VW

= 100% - 55% = 45%

Import limits increases the price of ethanol by 15%.Thus, the value added in the
industry at world prices = VT = 45% + 15% = 60%

The effective rate of protection for ethanol industry = ×100 = ×100

=

Questão 7

With a subsidy of 0.5, the export supply curve becomes

.

Now, the equilibrium world price is determined when;

The volume of trade is given by:

To determine the costs and benefits of the subsidy, the foreign demand and
supply curves are used as shown in the below diagram;
Foreign Demand & Supply Curve

As per the diagram, the welfare effect of export subsidy is given as:
Questão 8

a) The given statement is “False” because tariff rates do not directly influence the
unemployment rate in a country. Unemployment is more directly influenced by
trade cycles and the labor market situation of a country. However, tariff rates can
influence the employment situation in any sector of the economy. Suppose that
the import tariffs are imposed by a country & similar impositions are followed by
the other countries. In such a case, unemployment may be reduced in import
competing sectors relatively to export competing sector.

(b) The given statement is “False” because tariffs have more negative effect on
welfare in smaller countries than in large countries. In a small country, a tariff
imposed cannot reduce the foreign price of the good it imports. As a result, the
price of the import rises and the quantity of import demanded falls. Thus, the
effect on world price will be less and the terms of trade gains for the smaller
country will be less. Hence, it is concluded that the smaller country losses more
from a tariff than a larger country.

(c) An implementation of tariff on Automobile of the amount equal to the difference

between wage rates in both countries will have no impact on the price level. This
is because the reduction in cost due to lower wages paid to the workers of country
‘M’ will be canceled out with the implementation of tariff (Both amounts are same).
Hence, the price level will be unchanged and there will be no welfare loss.

Questão 9

Acirema is a small country importing peanuts at a price of $10 per bag.

The free trade equilibrium is given by the difference between demand and supply
equation:

Thus, the free trade equilibrium is bags of peanuts

So, Acirema imports 200 bags of peanuts.

An import quota that limits imports to 50 bags has the following effects which is
calculated and shown graphically below in the diagram.
Impact of the Import quota

(a) The increase in domestic price is given by the free trade equilibrium equation
which will be equal to the import quota:

(b)

Quota rents are the profits received by the holders of import licenses. It is
represented by the area c.

Thus, the quota rent is $500

(c)
Thus, the consumption distortion loss is $500.

(d)

Thus, the production distortion loss is $250.

Questão 10
In principle, tariffs and other forms of trade policies improve the terms of trade of
the countries. However, this argument hold good for large countries such as
United States and European countries which can influence the world price by
driving it down. Moreover these industrialized countries mainly import agricultural
based goods whose prices are influenced by tariffs or other trade policy
instruments.
Questão 11

If substantial tariff is levied on manufactured goods, wages in the manufacturing

sector will increase. This will decrease the real income of others in the economy.
This happens only when the wages in manufacturing sector is less than that of
other sectors. So, tariff improves the real income distribution within the economy
in case of wage discrepancy.