Question

Questions is based on the partial equilibrium analysis. Remember to draw relevant graphs for all questions.

3. Belgium is a small country. Suppose it consumes computer disks, some of which are produced domestically and some of which are imported from the rest of the world (ROW). It currently has a tariff on disk imports.

a. Explain how the tariff affects the domestic market, including price, production, consumption and imports of disks relative to the free trade case.

b. Explain how the Belgian government could replace the existing tariff with a quota that would have the exact same overall welfare effects. In this set up, would the income distribution effects for Belgium also be the same as for the tariff case?

c. How would the quota discussed in 3(b) differ from negotiating a VER (voluntary export restraint) with countries that export disks to Belgium (countries that are large enough to affect the world prices)? Assume that the VER results in the same level of imports as the quota in 3(b).

Answer 1

a) Tariff is a tax imposed by one country on its import of goods and services from other country. The effect of a tariff can be analyzed on the ground that how far it reduces consumer welfare and increase producers welfare and government revenue and how far it cause deadweight loss. A tariff generally raises the price of imported items. This reduces total satisfaction of consumers. But the producers are well off than before due to the increased price. The government gets extra revenue in the form of tariff. But the tariff cause production and consumption distortion which cause deadweight loss and which minus the total welfare available to the country. The success behind the tariff is how much it generates extra revenue to the nation. The relative effect of a tariff can be discussed with the help of demand and supply model. Price Market for computer Disk S Pw+t - - - - --- WSI -- C OF Pw -WS 01 02 03 04 Quantity Tariff increase the domestic price. Under free trade the domestic price is Pw. But the tariff increase the domestic price to Pw + t(world price plus tariff). Thus the imposition of a tariff raises the price in the domestic market. Under free trade the domestic producer produce a quantity equal to Q1. But a tariff with a price PW + t the domestic production increase from Q1 to Q2. Tariff increase domestic production, Under free trade the total consumption in the cconomy is Q3. But after the tariff the domestic consumption dccrcasc to Q3. Tariff reduces the domestic demand. Before tariff the quantity of import is Q1 Q4, but the tariff reduce the import quantity to Q2 Q3. Thus the imposition of a tariff reduces the quantity of import from the rest of the world. Thus the overall effects of a tariff are increase in domestic price, increased domestic production, decrease in domestic consumption, and decrease in import and increase in government revenue. b) The basic difference between tariff and quota is that there is a limit on the quantity of import under quola system. But there is no limit on the quantity of import under tariff. The tariff can be replaced with quota and both will have the same effect.

Price Market for computer Disk S(Quota) Quota B Pwit ---- - -- ------ wsi Pw WS Q1 02 03 04 Quantity Under tariff the total quantity of import was limited to Q2 Q3. The government can fix a quota on the same quantity. Under quota the production effect consumption effect and price effect are the same. Compare the case with tariff and quota. Under tariff total welfare loss is equal to the arca E and F. The same is also happens under quota. Under tariff the government gets revenue equal to the area F in the form of tariff. The same revenue is retained by the government in the form of quota rent. The distribution effect of quota is same as the tarift. Under tariff' a part of consumer surplus which is represented by the arca C is transferred from consumers to producers. The same distribution occurs under quota too. A part of consumers surplus which is represented by the area F is transferred to the government in the form of tariff, the same is transferred to the government in the for quota rent. c) The Voluntary Export Restrain (VER) is a protective method under which the exporting country restrains from exporting al lhe request of importing country. Under normal quota system the government gets quota rent if it administers the quota on auction (import license is given in auction). But under VER the importing country loose the revenue in the form of quota rent. Under VER the welfare in the exporting country increase as they can save the quota rent. Under quota the importing country ſix the limit of import whereas under VER the quantity is limited by the exporting country at the request of importing country. All other effects are the same both under quota and VER.