Question

1. Consider a large country applying a tariff t to imports of a good like that represented in Figure 8-9, as shown below. Figure 8-9 (a) Home Market (b) World Market Price Price X* +t b + d No-trade equilibrium SS D, D Quantity М. М. Imports a. How does the export supply curve in panel (b) compare with that in the small country case? Explain why these are different. b. Explain how the tariff affects the price paid by consumers in the importing country, and the price received by producers in the exporting country. Use graphs to illustrate how the prices are affected if (i) the export supply curve is flat or (ii) the export supply curve is upward sloping.

Answer 1

Part A

In the large country case, the export supply is upward sloping. Similarly, it is horizontal in a small country. It means that the supply of exports from the rest of the world is infinitely elastic at the world price. It follows the price-taking assumption under perfect competition. However, in the large country case, export supply is the price of export from other countries when a large country changes its import demand. Suppose the large country imposes a tariff it decreases the import demand and the price charged by the foreign exporters will fall.

Part B

Here the tariff shifts the export supply curve from X* to X*+t. The X*+t curve intersects import demand curve M at point C. it creates a new equilibrium. As a consequence, the price of importing country increases from PW to P*+t and the foreign price falls to PW to P*. the deadweight loss is the area of b and d. and the gain of trade of the importing country is e.

The total impact of the tariff on a large country is described based on the producer surplus, consumer surplus and government revenue.

Fall in CS	-(a+b+c+d)
Rise in PS	+a
Rise in government revenue	(c+e)
Net effect	+e-(b+d)

The triangles b and d is the deadweight loss due to the tariff. In a large country case, the gain is depicted as e. if e>b+d then importing country is better off. If e<b+d then importing country worse off.

The loss of foreign country is e and f and the net loss in world welfare is in the area of b+d+f.