Question

P ($) 14 13 12 11 10 9 8 7 6 5 5 9 7 6 8 11 13 15 17 19 21 Q 10 12 14 16 18 20 (Thous.)

The diagram above represents the market for T-shirts in the US, a small country. Vietnam can produce T-shirts at a constant cost of $6 per T-shirt. Mexico can produce T-shirts at a constant cost of $7 per T- shirt. Initially, the US has a $4 tariff per T-shirt. US consumers regard T-shirts made in the US, Vietnam, and Mexico as identical.

1. From which country will the US import T-shirts? Briefly explain

2. Draw a supply and demand diagram for the US market with the tariff. Label the relevant prices

   and quantities.

3. Draw a supply and demand diagram for the international market with the tariff. Label the

   relevant prices and quantities.

Now suppose the US and Mexico form a free trade area so that Mexican goods enter the US tariff free.

4. From which country will the US import T-shirts? Briefly explain.

5. Draw a supply and demand diagram for the US market with the free trade area. Label the

   relevant prices and quantities.

6. Draw a supply and demand diagram for the international market with the free trade area. Label

   the relevant prices and quantities.

7. Label the area(s) in your diagram for part (e) that show the gains or losses to US consumers from the free trade area. Calculate their $ value.

8. Label the area(s) in your diagram for part (e) that show the gains or losses to US producers from the free trade area. Calculate their $ value.

9. Label the area(s) in your diagrams for parts (e) and (f) that show the change in tariff revenue for the US government from the formation of the trade area. Calculate the $ change in government revenue.

10. Does the US experience a net welfare gain or loss from the formation of the free trade area? (Briefly explain.)

Answer 1

In the domestic market US producers charges a price of $13 per t-shirt but Vietnam can produce the same t-shirt at $6 and Canada for $7.but now there is a import tariff imposing by the US government of $4 per t-shirt so the selling price of t-shirt produced in vietnam is ($6+$4)=$10 and for canada ($7+$4)=$11.and if we consider no transport cost then US will import t-shirt from vietnam as all t-shirts are identical to the consumer.here in the diagram we measure vertical axis price and quantity(thousand) horizontal axis.herr Dd is the domestic demand for t-shirt in US.and SV is the supply curve for vietnam and SC is the supply curve for canada.here we clearly see the vietnam price is $10 and quantity sold is 16thousand compare to canada price is$11 and quantity sold 15thousand.so clearly US import t-shirt from vietnam.but there may be another cases.as vietnam is far away from US compare to Canada shares its border with US.and if we assume transportaion cost from vietnam is $1 per tshirt then the selling price of vietnam produce t-shirt will also became $11 same as Canada then US can import from vietnam or canada or both as it charges the same price.another thing can also happen,vietnam is a small country a US is a large country as it is impossible for vietnam to meet the total demand of t-shirt of US.if we assume vietnam can only export 6thousand t-shirt to US then the extra 10 thousand must be import from canada.

Now if mexico goods comes to US as tariff free then t-shirt don't have to pay $4 tariff so now the price for canadian t-shirt falls to $7here in this figure we can clearly see price is $7 and as price falls demand also rises to 19 thousands.here one thing we have to consider that no such trade agreement is occured with vietnam so US now charged tariff $4 for vietnam shirt.so no one want to purchase vietnam tshirt as it is at higher cost of $10.

The US consumers gain due to free trade from Canada.here in this figure we consider two situation where price before trade is $13 and after free trade they have to paid only $7.so each consumer save $6 after.and before high price many individual can't buy tshirt but after price cut new buyers enter.so total gain of the consumer is the box 7AC13.

PUR MR So 13 Lo so 7 t Dd 13 19 Thoug

But from the free trade US producers loss hugely.as before trade they charges high price $13 but when the price is $7 most of the producer will leave the market.in this figure we clearly see at price $7 US producers only supplies 7thousands compare to before 13 thousands at $13.so there loss is($13*13000)-($7*7000)=$110000.which is the box area 13CBE7,13.

from the free trade US gains the same amount which is equal to consumer surplus.here the loss of producers is offset by the consumer surplus.

The US government earns tax revenue of $4*6,000=$24,0000.as 10thousands will be supply by the US producers at price $10.