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7.4 The graph below shows an equilibrium point, B, corresponding to the intersection of
Home import demand and Foreign export supply. In this exercise we compare two
potential export supply curves: X1* and X2*.
a) Which export supply curve has a higher elasticity of export supply at point B.
Interpret the meaning of this difference in words.
X2* has a higher elasticity of export supply at point B, which means a given
percentage change in price will induce a larger percentage change in quantity
exported, in another word, export responds more to a given price change.
b) Suppose that the Home country imposes a tariff of t. Show the effect on both
export supply curves of the tariff.
A tariff will shift both export supply curves upward by t, as shown below:
t
c) Draw the Home supply and demand diagram for this good beside (to the left of)
this graph. Illustrate on your graphs the price seen by Home consumers and price
received by Foreign producers.
S
X1*
P2M
X2*
P1M
PW
P2X
P1X
M
D
X2 X1
Note:
- P2M = the price seen by home consumers when foreign export supply curve is X2*
- P1M = the price seen by home consumers when foreign export supply curve is X1*
- PW = the price seen by home consumers and foreign firms when there is no tariff
- P2X = the price received by foreign firms when foreign export supply curve is X2*
- P1X = the price received by foreign firms when foreign export supply curve is X1*
d) What can you say about the relationship between the elasticity of Foreign export
supply and the amount of the tariff absorbed by Foreign producers?
The higher the elasticity of foreign export supply, the smaller the amount of the tariff
absorbed by foreign producers.
8.1 Assuming perfect competition in the Home industry, rank the following in ascending
order of Home welfare and justify your answers. If two items are equivalent, indicate as
such accordingly.
a) Quota of M in a small country, with quota licenses distributed to non-rent-seeking
Home firms.
b) Quota of M in a small country, with quota licenses auctioned.
c) Quota of M in a small country, with the responsibility of implementing the quota
given to the exporting country.
d) Quota of M in a small country, with quota licenses distributed to rent-seeking
Home firms.
Measured in total national welfare, from lowest to highest: c) < d) < a) = b). Case a)
and b) have the same welfare effect, where rent is earned by domestic residents
without (significant) loss. Case d) incurs some waste in the process of rent-seeking,
which could be as large as the rent. In case c) all rent is earned by foreigners.
8.2 Extend question 8.1 by also ranking the three tariff scenarios listed in d), e) and f),
under perfect competition, and the quota in h) with imperfect competition. Compare each
of these to the quotas in a), b), c) and d). If two items cannot be ranked, just indicate that.
a) Quota of M in a small country, with quota licenses distributed to non-rent-seeking
Home firms.
b) Quota of M in a small country, with quota licenses auctioned.
c) Quota of M in a small country, with the responsibility of implementing the quota
given to the exporting country.
d) Quota of M in a small country, with quota licenses distributed to rent-seeking
Home firms.
e) Tariff, t, in a small country corresponding to the quantity of imports M.
f) Tariff, t, in a large country corresponding to the same quantity of imports M.
g) Tariff, t’, in a large country corresponding to the quantity of imports M’>M.
h) Quota of M in a small country, but with Home monopoly.
First of all, case e) has the same welfare effect as case a) and b). Case f) has a higher
national welfare than cases a), b) or c) does, because a large country can benefit from
the improvement of terms of trade when setting a tariff. But we cannot say which one
of case f) and g) is better, since we have no idea about the export elasticity and thus
the optimal tariff. Neither can we compare case g) and e). As for case h), it incurs an
efficiency loss compared to cases a), b) and e), since quota splits the market and now
the domestic firm can act as a monopoly firm and thus lead to a dead weight loss.
Summary (ordered by total national welfare):
f) > a) = b) = e) > d) > c)
g) ? f), g) ? e)
a) = b) = e) > h)
Illustration 1: case e) vs. case f)
S
XS’
XS
PW
a
b
c
d
b+d
e
e
MD
D
Net welfare change in case e): – (b + d)
Net welfare change in case f): e – (b + d)
Illustration 2: case a) vs. case h)
S
PW
a
b
c
MC
d
D
S1 S2
D2
D1
Net welfare change in case a): – (b + d)
MR
S2 S1
D-M
D2
D
D1
Net welfare change in case h): – (b + d + efficiency loss due to monopoly)
9.1 Ceteris paribus (i.e. all else unchanging), describe the impact of each of the following
outcomes of the Hong Kong WTO meeting on world prices and domestic prices of a
large country:
a) The abolition of agriculture export subsidies
Once export subsidies of a large economy are abolished, the country will export less
agricultural products and thus world prices will rise and domestic prices will fall.
b) The reduction of agricultural tariffs
The reduction of tariffs will stimulate the exports of agricultural products to the
country and result in higher world prices and lower domestic prices.
Duty-free quota-free access for 97% of goods originating in the world’s least
developed countries
This has the same effect as in a) and b), i.e. higher world prices and lower domestic
prices of the goods in concern.
c)
9.2 Consider a large country with export subsidies in place for agriculture. Suppose the
country changes its policy and decides to cut its subsidies in half.
a) Are there gains or losses to the large country, or is it ambiguous? What is the
impact on domestic and foreign prices for agriculture?
S
P’+s
P’’+s/2
a
b
c
XS
d
XS’’
PW
XS’
P’’
P’
MD
D
D1D2
S2 S1
X2
X1
Welfare analysis:
For consumers, price decreases from P’+s to P’’+s/2, consumers gain by a+b.
For producers, price decreases from P’+s to P’’+s/2, producers lose by a+b+c
For government, subsidy cost falls by b+c+d+the shaded area
Total national welfare increases by b+d+the shaded area, which means the exporting
country benefits from a subsidy cut policy.
b) Suppose a small food-importing country elsewhere reciprocates by lowering its
tariffs on agriculture by the same amount. Are there gains or losses to the small
country, or is it ambiguous? Is there a net overall gain?
For a small food-importing country, it suffers from the subsidy-reducing policy of the
large country since the world price becomes higher, which means a decline of terms
of trade for the small country. On the other hand, if the small economy cuts tariff, it
can reduce the efficiency loss as long as it remains as an importing country. The
overall welfare effect is ambiguous, though.
Suppose a large food-importing country elsewhere reciprocates by lowering its
tariffs on agricultural goods by the same amount. Are there gains or losses to this
large country, or is it ambiguous? Is there a net overall gain?
For a large food-importing country, a tariff cut policy will shift the export supply
curve in the international market down, thus completely counteract the subsidy cut
policy, so the world price remains constant. Consequently, the welfare effect is
completely determined by efficiency loss caused by tariff. If the large importing
country remains as an importing country, the DWL is definitely lower than before,
and the country gains for sure. The country may also lose if s>4t.
c)