Question

Consider the case of a Foreign monopoly with no Home production. Starting from free trade
equilibrium and consider a $10 tariff applied by the Home government, answer the following
questions.
a. If the demand curve is linear [P = 10 - Q], what is the shape of the marginal revenue
curve?
b. How much does the tariff-inclusive Home price increase because of the tariff, and how
much does the net-of-tariff price received by the Foreign firm fall?
c. Discuss the welfare effects of implementing the tariff. Use a graph to illustrate under what
conditions, if any, there is an increase in Home welfare.

Answer 1

Given that, Foreign monopoly with no home production. $10 tariff applied by the Home government (a) If the demand curve is linear: P= 10-Q Revenue = PQ = (10-00 = 10Q-Q^2 Therefore, the marginal revenue is as follows: MR = 10 - 20 Hence, the shape of the marginal revenue curve would be downward sloping if the demand curve is linear, as shown in figure 1. (b) Tariff = $10 In figure 1, Marginal cost curve shifts upwards from MC to (MC+t) by the amount of tariff. Home price increases from P1 to P2 and foreign price falls to (P3 = P2 - 10), at a point where old MR curve with new MC curve.

May 2018 22 Tuesday Wk 21 Appointments Price 10 P2 P. P=1-10 11 Ver Me t t (me +$10) Increase in 12 MC cont due to 't Demand 13 AMR 14 X O Xr Foreign Exports IS Figure 16

Wk-21 nents D Price S Putt A C D B Pw S Q. Comentity Figure 2

(c) Now, we are analyzing the welfare effects after imposing tariff. Here, we assume that home nation size is small. In figure 2, the initial world price is at Pw and after the imposition of tariff; it increases to (Pw+t). Before tariff, Consumer surplus = A + B + C +D Producers surplus = 0 Government revenue = 0 After tariff, Consumer surplus =- (A+B+C+D) Producers surplus = + A Government revenue = + C Welfare = -(B+D) Where, 'B' represents the production distortion loss and 'D' represents the consumption distortion loss. Hence, there is a fall in the welfare because the tariff is imposed by the small country. The conditions under which tariff results in an increase in the welfare are as follows: If the tariff is imposed by the large country because a small amount of tariff or tax implemented by the large country would result in an increase in the national welfare.