Question

7. On the graph below, using Supply and Demand, show what happens if a "small" country implements a tariff in an import industry. Draw the necessary domestic demand and supply curves. Be sure to label the axes and any curves. Show where the domestic market clearing price is, the World Price, and the price in the market are after the tariffs are implemented. Indicate the areas of Consumer Surplus, Producer Surplus, Government Revenue, and Deadweight Loss under the tariff. (5 points)

Answer 1

In following graph, AB & CD are domestic demand and supply curves of the good in question.

Domestic equilibrium is at point E with equilibrium price P1 and quantity Q1.

Free trade world price is P* at which domestic demand is Q2 and domestic supply is Q3, so imports are (Q2 - Q3).

Consumer surplus (CS) = Area between demand curve and world price = Area AFP*

Producer surplus (PS) = Area between supply curve and world price = Area CGP*

An import tariff will increase domestic price from P* to Pt, at which domestic demand falls to Q4 and domestic supply rises to Q5, so imports are (Q4 - Q5). The tariff reduces imports.

After tariff,

New CS = Area AHPt

New PS = Area CJPt.

Decrease in CS = Area PtHFP* (loss to consumers)

Increase in PS = Area PtJGP* (gain to producers)

Tariff revenue = Area PtHLP*

Deadweight loss = Area FHL + Area GJK

63 91 9 9, 82 8