Download Econ 4550/6550 International Trade Assignment 6/Solutions 1

Econ 4550/6550
International Trade
Assignment 6/Solutions
1.
Refer to the above figure and answer the following questions.
(a)
(b)
(c)
(d)
(e)
(f)
In the absence of trade, how many Widgets does this country produce and consume?
In the absence of trade, what is the country’s consumer plus producer surplus?
With free trade and no tariffs, what is the quantity of Widgets imported?
With a specific tariff of $3 per unit, what is the quantity of Widget imports?
What is the loss of Consumer Surplus due to the tariff?
What is the lowest specific tariff which would be considered prohibitive?
[6 x 2 = 12]
Answer:
(a) In the absence of trade, the country must produce everything it wants to consume; so
domestic demand must equal domestic supply and the country produces and consumes 60
widgets.
(b) Notice that both the domestic demand and supply curves have the same slope (tan =
perpendicular/base = 1/10 for both curves). Therefore, consumer and producer surplus in
the absence of trade will be identical. These will be given by 0.5(60)(6) =$180 each. So
consumer surplus plus producer surplus is $360.
(c) The quantity of widgets imported with free trade is 100-10 = 90
(d) With the tariff in place, widget imports will decline to 80-40 = 40
(e) The loss in consumer surplus is $230.
(f) For the tariff to be prohibitive, it must raise the post-tariff price to the autarky price. Hence
the prohibitive tariff must be at least $5 per widget (autarky price – free trade price).
2. Some argue that tariffs always hurt the imposing country’s economic welfare, and are typically
designed to shift resources from one sector to another, protected or preferred one, within an
economy. Find and discuss a counterexample to this argument.
[4]
Answer:
A counter-example to the above argument is the existence of an optimum tariff, which theoretically
could be a first-best trade policy if the terms of trade gain exceed the distortion losses.
3. The two deadweight triangles associated with the graphical analysis of a tariff are the Consumption
distortion and Production distortion losses. It is easy to understand why the Consumption distortion
constitutes a loss for society. After all it raises the prices of goods to consumers, and even causes
some consumers to drop out of the market altogether. It seems paradoxical that the Production
distortion is considered an equivalent burden on society. After all, in this case, profits increase, and
additional production (with its associated employment) comes on line. This would seem to be an
offset rather than an addition to the burden or loss borne by society. Explain why the Production
distortion is indeed a loss to society, and what is wrong with the logic that leads to the apparent
paradox.
[4]
Answer:
The Production distortion is a loss to society because it constitutes a loss to consumer surplus, which is
not recouped by any other group in society. The actual triangle here represents an inefficient shift of
society’s resources to produce a good, which it could not sell profitably at world prices. The basic
point here is that the country ends up producing more than it should at the free trade equilibrium.