Question

Imagine if there was such a thing as an export tariff. Using the model we’ve been using in class (i.e. Food
and Cloth, with the Home country being relatively more efficient at producing cloth than Foreign):
a) Graph the effects of Home imposing an export tariff on the relative supply and relative demand for cloth
b) Determine what happens to the relative price of cloth in the Home country
c) Determine what happens to the terms of trade in the Home country

Answer 1

Pc/Pf RS1 RS2 e1 (Pc/Pf)1 (Pc/Pf)2 RD1 RD2 Q1 (Qc+Qc*)/(Qf+Qf*)

1. The effect of export tariff falls on both the relative demand and relative supply. The relative demand for cloth falls because of export tariff because of higher price of exports. However, the relative supply of cloths in the home country increases because the producers (domestic) find it profitable to supply at the greater price after the increase in price due to export. The quantity however depends on the relative strength of the shift in the relative demand and supply of cloth.

          From the graph, the relative price of cloth falls.

c) Terms of trade defined as the index of price of exports divided by the index of price of imports for home country deteriorates. This is because the relative price of Home countries exports fall.