Question

3. Welfare effects of a tariff in a small country Suppose New Zealand is open to free trade in the world market for wheat. Because of New Zealand's small size, the demand for and supply of wheat in New Zealand do not affect the world price. The following graph shows the domestic wheat market in New Zealand. The world price of wheat is Pw $250 per ton. On the following graph, use the green triangle (triangle symbols) to shade the area representing consumer surplus (CS) when the economy is at the free-trade equilibrium. Then, use the purple triangle (diamond symbols) to shade the area representing producer surplus (PS)

Based on your analysis, as a result of the tariff, new Zealand's consumer surplus (increase/decrease) by $______________, a producer surplus *(increase/Decrease) by $__________, and the government collects $____________ in revenue. Therefore, the net welfare effect is a (gain/loss) by $____________.

Answer 1

Import = Quantity demanded - Quantity supplied = 160 - 40 = 120 tons of wheat

Price consumers pay = 250 + 60 = $ 310

Import = 120 - 80 = 40 tons of wheat

Under Free Trade;

Consumer surplus = 1/2 x base x height = 1/2 x 160 x (490 - 250) = 80 x 240 = 19200

Producer surplus = 1/2 x 40 x (250 - 190) = 20 x 60 = 1200

Under a tariff;

Consumer surplus = 1/2 x 120 x (490 - 310) = 60 x 180 = 10800

Producer surplus = 1/2 x 80 x (310 - 190) = 40 x 120 = 4800

Government revenue = (310 - 250)(120 - 80) = 60 x 40 = 2400

Consumer surplus decreases by 19200 - 10800 = 8400

Producer surplus increases by 4800 - 1200 = 3600

government collects 2400 as revenue

net welfare effect is a loss of 1/2 x (310 - 250) x (80 - 40) + 1/2 x (310 - 250) x (160 - 120) = 30 x 40 + 30 x 40 = 2400