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Because of the _______ (reduction, increase) in producer surplus the domestic producers lobby the government to impose 100% ad valorem tariff (T=100%) on foreign products: T = ____$
| Prohibitive tariff: a tariff which is set so high that it makes all imports unprofitable. |
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1) Where is the tariff-inclusive foreign supply curve? ________
2) What is the tariff-inclusive world price and the tariff-inclusive world quantity? ________________________________
3) What is the quantity the domestic producers supply? _______
4) What is the quantity the domestic consumers demand? ______
5) What is the quantity the foreign producers supply
(the quantity of imports)? ______________________________
6) What is the area of domestic consumer surplus after the tariff? ___________
7) What is the area of domestic producer surplus after the tariff? ___________
8) What is the area of the tax revenue collected by the government? __________
Please, compare the market situations: under free trade and after the tariff.
1. Market price ___________________________________________________
2. The quantity the domestic producers supply __________________________
3. The quantity the domestic consumers demand _________________________
4. Imports ______________________________________________________
5. Domestic consumer surplus _______________________________________
6. Domestic producer surplus _______________________________________
Please, fill in the blank.
By placing the tariff on foreign goods, this __________(raises, drops) the price from ____$ to ____$. Next, because the tariff drives the price up for consumers, this __________ (reduces, increases) the quantity demanded from point ___ to point __ (from ____ units to ____ units). Because of the tariff, the domestic quantity supplied ____________ (decreased, increased) from point ____ to point ______ (from ____ units to ____ units).
So who is hurt and who benefits from this tariffs?
As a result of the tariff the domestic consumer surplus ____________ (decreases, increases) from the area _________ to the area __________ where as the domestic producer surplus ____________ (decreases, increases) from the area __________ to the area _________. The domestic producers use the argument that the tariff creates more domestic jobs in that particular industry. However, the domestic producers fall to mention that these domestic jobs are created at the expence of a loss of consumer surplus: the producer takes part of the consumer surplus equal to the area _________________________.
Besides the domestic producer and domestic workers in that particular industry, the government also gains tariff revenue of the area ___________.
Are the domestic consumers happy when the government imposes a tariff on foreign goods? _______. Consumers are the ones that are hurt by the tariff. The tariff just reduses the consumers surplus: the net loss in consumers surplus is the area _____________________________. This consumers loss is distributed amongst: increased producer surplus (area__________), government tariff revenue (area__________), and deadweight losses (area__________).
_________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
Redistribution effect: __________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
Deadweight loss or protection cost – net national loss from the tariff because of inefficiencies in production and consumption resulting from a tariff. It includes the parts of consumers loss as a result of a tariff that shift to neither the government nor producers. In other words no entity (government or producer) picks up this loss. The areas _______ and ________ are the efficiency loss due to the imposed tariff.
Production effect of the tariff – the cost of shifting to more expensive home production in the import-competing sector, which is protected by the tariff on foreign goods. The area ________ is the producer efficiency loss due to increased costs of shifting to more expensive domestic production.
Consumption effect of the tariff – the welfare loss to consumers in the importing nation that corresponds to their being forced to cut their total consumption as a result of the tariff. The area ________ is the consumers efficiency loss due to the consumers reduction in product consumption.
Please, answer the questions.
1) What happens to the price when the government decides to impose a tariff on foreign goods coming into the country? ________________________________
2) What happens to the quantity of goods demanded? _____________________
3) What happens to the domestic quantity of goods supplied? _______________
4) What quantity is going to be supplied by the foreign producers (imported)?
______________________
5) Who benefits from imposing tariff? _________________________________
6) Who is hurt by imposing tariff? _____________________________________
7) What is the area of the domestic consumer surplus loss after the tariff? ______
8) What is the area of the domestic producer surplus gain after the tariff? ______
9) What is the area of the gain of the government after the tariff? ___________
10) What is the area of the deadweight loss after the tariff? _________________
11) What is the area of deadweight loss due to reduced product consumption because of the tariff? __________________________________________________
12) What is the area of deadweight loss due to the inefficiancy of domestic producers? __________________________________________________________
Please, refering the example considered above fill in the table below
Welfare Cost of a Tariff Imposed by a Small Nation
| Welfare Change (Area) | ||||
| Change in consumer surplus | ||||
| Change in producer surplus | ||||
| Change in government revenue | ||||
| Net welfare change |
So, levying an import tariff __________ (increases, reduces) a small country's welfare.
SUMMARY
Whenever a small country implements a tariff, national welfare falls. An import tariff of any size will result in deadweight losses and reduce production and consumption efficiency. The national welfare effect of an import tariff is evaluated as the sum of the producer and consumer surplus and government revenue effects. The tariff causes a redistribution of income: producers and the recipients of government spending gain, while consumers lose. Because the country is assumed to be small, the tariff has no effect on the price in the rest of the world; therefore, there are no changes for foreign producers, consumers or national welfare in the foreign country.
Tariff effects on the importing country’s consumers. Consumers of the product in the importing country are worse off as a result of the tariff. The increase in the domestic price of both imported goods and the domestic substitutes reduces consumer surplus in the market.
Tariff effects on the importing country’s producers. Producers in the importing country are better off as a result of the tariff. The increase in the price of their product increases producer surplus in the industry. The price increases also induce an increase in the output of existing firms (and perhaps the addition of new firms), an increase in employment, and an increase in profit, payments, or both to fixed costs.
Tariff effects on the importing country’s government. The government receives tariff revenue as a result of the tariff. Who will benefit from the revenue depends on how the government spends it.
Tariff effects on the importing country. The aggregate welfare effect for the country is found by summing the gains and losses to consumers, producers, and the government. The net effect consists of two components: a negative production efficiency loss (b) and a negative consumption efficiency loss (d). The two losses together are typically referred to as “deadweight losses.”
EXERCISES
TOPIC#3.
TARIFF REGULATION:
IMPACT OF TARIFF ON THE ECONOMY OF A “SMALL” COUNTRY
Exercise#1. Please fill in the blank and answer the questions referring to the figure.
1. Before the tariff is imposed, the quantity supplied by domestic producers and the quantity imported equal, respectively: ______; ______
2. Imposition of the tariff causes the quantity of imports to: _____________ by __________
3. Government revenue collected from this tariff equals: ____________________
4. How are domestic consumers and producers affected by the tariff?
a) Domestic producer surplus increases by the area a, b, d, and e;
b) Domestic consumer surplus increases by the area a, c, h, and d.
c) Domestic consumers gain by the imposition of the tariff on imports
d) All of the above
5. What is the meaning of the triangle cgh?
a) The triangle represents a loss of producer surplus arising from the reduction in market quantity.
b) The triangle represents a loss of consumer surplus due to the reduction in market quantity and the increase in price.
c) The triangle represents a gain to producers who receive a higher price and produce a higher quantity domestically.
d) The triangle represents a gain of consumer surplus due to the reduction in imports.
6. The effect of an import tariff is to:
a) Increase both domestic production and consumption.
b) Decrease both domestic production and consumption.
c) Increase domestic production and decrease domestic consumption
d) Increase domestic consumption and decrease domestic production
Exercise#2. Consider the following partial equilibrium diagram depicting the market for radios in Portugal, a small importing country. Suppose PFT is the free trade price and PT is the price in Portugal when a tariff is in place. Answer the following questions by referring to the diagram. Assume the letters, A, B, C, D, and E refer to areas on the graph. The letters v, w, x, and y refer to lengths. (Be sure to include the direction of changes by indicating “+” or “−.”)
1. Where on the graph is the level of imports in free trade? ____________
2. Which area or areas represent the consumer surplus in free trade? ____________
3. Which area or areas represent the producer surplus in free trade? ____________
4. Where on the graph is the size of the tariff depicted? ____________
5. Where on the graph is the level of imports after the tariff depicted? ____________
6. Which area or areas represent the tariff revenue collected by the importing government with the tariff in place? ____________
7. Which area or areas represent the change (+/−) in consumer surplus when the tariff is applied?
___________________
8. Which area or areas represent the change (+/−) in producer surplus when the tariff is applied?
__________________
9. Which area or areas represent the change (+/−) in national welfare when the tariff is applied?
__________________
Exercise#3. As a result of setting free trade in Ukraine the domestic price for TVset decreased from 1650 UAH to 1375 UAH (see the diagram). What is the consequences - loss (gain) - for the domestic TV manufacturers, consumers and the economy as a whole?
1) Consequences for the domestic TV manufacturers:
____________________________________________________________________
____________________________________________________________________
2) Consequences for the domestic TV consumers:
____________________________________________________________________
____________________________________________________________________
3) Consequences for the economy:
____________________________________________________________________
____________________________________________________________________
Exercise#4. As a result of imposing import tariff in Ukraine the domestic price for 1 ton of sugar increased from 1800 UAH to 2400 UAH (see the diagram). What is the consequences - loss (gain) - for the domestic TV manufacturers, consumers, budget and the economy as a whole?
1) Consequences for the domestic sugar manufacturers:
____________________________________________________________________
____________________________________________________________________
2) Consequences for the domestic sugar consumers:
____________________________________________________________________
____________________________________________________________________
3) Consequences for budget:
____________________________________________________________________
____________________________________________________________________
4) Consequences for the economy:
____________________________________________________________________
____________________________________________________________________
Exercise#5. Suppose that there is a small country, importing peanuts at the price of $10 per bag. The country’s demand curve for peanuts is D = 400 - 10P. Its domestic supply curve is S = 50 + 5P. Please, determine price, demand and supply both for the free trade and closed economy.
| P, $ |
| Q, bags |
1. Free trade:
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
Answer: P = $____; Qd=_______; Qs=______.
2. Closed economy:
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
Answer: P = $____; Qd=_______; Qs=______.
Exercise#6. Please, consider 2 market situations below and answer the quections.
Market situation 1: with tariff (under protection). Price of bicycle is 150 $/unit; tariff rate is 40 $/unit; consumption – 100 mln. units per year; production – 40 mln. units per year.
Market situation 2: Free trade zone. Tariff is cancelled. Price of bicycle is 110 $/unit; consumption – 120 mln. units per year; production – 26 mln. units per year.
What is the impact (gain or loss) of cancelation of the tariff on:
a) consumers (consumer surplus); b) producers (producer surplus);
c) government (budget); d) economy as a whole?
| P, $ |
| Q, mln. units |
________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________
Exercise#7.
1. Suppose that U.S. market demand and supply functions for cloth are given, respectively, by Qd=140-20P and Qs=20P-20, where P is given in dollars. Assume that the cloth industry and the U.S. are small.
| P, $ |
| Q, mln. units |
a) Plot the U.S. demand and supply curves for cloth and indicate the equilibrium price and quantity for cloth in the U.S. in the absence of trade.
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
b) If the U.S. now allows free trade and P=2 on the world market, the world supply of cloth is infinitely elastic at P=2 and we assume no transportation costs, what will P be in the U.S.? How much cloth will the U.S. consume, produce and import with free trade?
What are the changes in producer and consumer surplus?
_______________________________________________________________________
_______________________________________________________________________
______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
______________________________________________________________________
2. If, from the free-trade position, the U.S. imposed a 50% ad valorem (nominal) tariff on its cloth imports
a) draw a figure showing the new P in the U.S. and consumption and production effects of the tariff, as well as, import reduction and revenue collected by the goverment.
What are the changes in producer and consumer surplus?
_______________________________________________________________________
_______________________________________________________________________
______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
______________________________________________________________________
_______________________________________________________________________
b) What would constitute a prohibitive tariff on cloth?
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
Exercise#8. Suppose that free trade price of a good is $12 and a 10 percent ad valorem tariff is put in place. As a result, domestic production in a small country rises from 2000 units to 2300 units and imports fall from 600 units to 200 units.
1. Who are the winners and losers?
2. What is the size of their gains and losses?
3. What is the net effect on the economy?
1. Who are the winners and losers?
_______________________________________________________________________
_______________________________________________________________________
2. What is the size of their gains and losses?
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
3. What is the net effect on the economy?
_______________________________________________________________________
_______________________________________________________________________
_______________________________________________________________________
Exercise#9. Impact of tariffs on business and consumers.
Please, read the following information. Then answer the questions which relate to the information. The country’s name is Fictionland. Its legislature has just passed a new tariff law to protect jobs and business in the Fictionland sugar industry. There are the following facts about the sugar industry as it operated before the new tariff was approved:
1) There are 10 sugar producers in Fictionland.
2) They produce 500 000 pounds of sugar each month.
3) At this time the Fictionland sugar producers cannot expand their production.
4) Foreign sugar producers also sold a total of 500 000 pounds of sugar per month in Fictionland.
5) Consumers bought 1 million pounds of sugar per month at a price of $2 per pound.
Tariff supporters argued that the tariff would raise money for the government to help balance the budget without raising the taxes of Fictionland citizens. It would also help preserve jobs and businesses in a traditional part of the economy – the sugar industry. There was little opposition to the bill, and it passed a vote in the legislature by a wide margin.
Consequences of the tariff for sugar industry:
1) Foreign producers reacted to the higher costs imposed by the tariff by supplying less sugar to Fictionland. They reduced their sales to Fictionland by one half.
2) Prices rose from $2 per pound to $3 per pound. Local economists explained that supply declined while demand for sugar remained stable, so market prices rose to a new equilibrium level.
3) Domestic sugar producers continued to make and sell 500 000 pounds of sugar per month. They now could charge a price of $3 per pound.
Please, consider how do tariffs influence business, answer the following questions and decide whether the tariff has helped the Fictionland consumer.
QUESTIONS:
| Before Tariff | With Tariff | |
| 1) Price, $ per pound | ||
| 2) Quantity demanded, pounds of sugar per month | ||
| 3) Quantity supplied by domestic businesses, pounds of sugar per month / share in the total supply | ||
| 4) Quantity imported, pounds of sugar per month / share in the total supply |
9. How much extra money must consumers pay to receive the 500 000 lbs. of Fictionland sugar made by Fictionland producers? ______________________________________________
10. How do tariffs influence the revenues of domestic business firms that are protected by the tariffs? _________________________________________________________________
11. Why might tariffs be viewed as giving money to domestic business? _________________________________________________________________________
12. Who has the strongest financial incentive to influence legislation on tariffs?
_________________________________________________________________________
Exercise#10. Please, answer the test questions below.
1. The imposition of a tariff:
a) generates revenue which is paid entirely by foreigners;
b) always increases the domestic price in the exporting country;
c) reduces the welfare of a “small” importing country relative to free trade;
d) is always welfare-increasing.
2. When a nation imposes an import tariff,
a) the domestic price of the importable commodity rises;
b) domestic consumption of the importable commodity falls;
c) domestic production of the importable commodity increases;
d) the volume of imports of the importable commodity falls;
e) all of the above.
3. A tariff on imports causes a redistribution of income from:
a) the producers of the import competing products to the revenue collecting government;
b) the consumers of the importing country to the producers and the revenue collecting government;
c) the consumers of the exporting country to the consumers of the importing country;
d) the producers of the importing country to the exporting country government.
e) the government to the producers of the import competing product.
4. The aggregate welfare effects of a tariff implemented by a “small” country results in:
a) production efficiency gain;
b) a deadweight loss;
c) consumption efficiency gain;
d) loss in producer surplus;
e) an increase in economic well-being.
Exercise#11. True or false?
1. Protectionism is a politician's delight because it delivers visible benefits to the protected parties while imposing the costs as a hidden tax on the public.
_______
2. An import tariff will increse the quantity of imports.
_______
3. An import tariff will raise the domestic price and, in the case of a small country, leave the foreign price unchanged.
_______
4. In case of a small country, an import tariff will lower the domestic price of a commodity.
_______
5. The quantity of imports in the country will decline once the tariff is implemented.
_______
6. The tariff will lower the world price of the commodity.
_______
7. The domestic price of imports and import-competing goods will rise by the full amount of the tariff.
_______
8. The tariff will increase the domestic price to match the world price of the commodity.
_______
9. A specific import tariff implemented by a small importing country will raise the domestic price of imports by the full value of the tariff.
_______
Exercise#12. Please, consider the Import Tariff Reduction by a Small Country filling in the table below. In the empty boxes, use the following notation to indicate the effect of the policy on the variables listed in the first column. Use the following notation: “ +” – the variable increases; “ −” – the variable decreases; “ 0” – the variable does not change.
Trade Policy Effects: Import Tariff Reduction by a Small Country
| 1. Domestic Market Price | |
| 2. Domestic Industry Employment | |
| 3. Domestic Consumer Welfare | |
| 4. Domestic Producer Welfare | |
| 5. Domestic Government Revenue | |
| 6. Domestic National Welfare | |
| 7. Foreign Price |
Exercise#13. Please, look at the picture and show the areas of gain or loss for the domestic 1) producers, 2) consumers and 3) economy as a whole of a small country after canceling the tariff and setting a free trade.
1) Gain / Loss for the domestic producers:
____________________________________________________________________
____________________________________________________________________
2) Gain / Loss for the domestic consumers:
____________________________________________________________________
____________________________________________________________________
3) Gain / loss for the economy as a whole:
____________________________________________________________________
____________________________________________________________________
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