Question

The accompanying diagram illustrates the U.S. domestic demand curve and domestic supply curve for beef. Price of beef Domestic supply P A P Domestic demand Q Ost Our Q, Quantity of beef The world price of beef is Pw. The United States currently imposes an import tariff on beef, so the price of beef is Pr. Congress decides to eliminate the tariff. In terms of the areas marked in the diagram, answer the following questions. a. With the elimination of the tariff what is the gain/loss in consumer surplus? b. With the elimination of the tariff what is the gain/loss in producer surplus? c. With the elimination of the tariff what is the gain/loss to the government? d. With the elimination of the tariff what is the gain/loss to the economy as a whole?

Answer 1

World price= Pw

Price with tariff= P_T

Consumer surplus= Area above price and below demand curve

Producer surplus= Area above supply curve and below price

Price of beef Domestic supply E P F B: C:D PG G Domestic demand Ost Qur Q Quantity of beef

a.

Consumer surplus with P_T = Area(E+F)

Consumer surplus at Pw= Area(A+B+C+D+E+F)

If government eliminate the tariff:

Change in consumer surplus= Area(A+B+C+D+E+F)- Area(E+F)= Area(A+B+C+D)

There will be a gain in consumer surplus of area (A+B+C+D)

b.

Producer surplus with P_T = Area(A+G)

Producer surplus with P_w = Area(G)

Change in producer surplus= Area(G)-Area(A+G)= -Area(A)

There will be a loss in producer surplus by area(A).

c.

Government revenue with tariff= Area(C)

Government revenue without tariff = 0 (Because without tariff government is not earning anything)

Change in government revenue= 0-Area(C)= -Area(C)

There will be a loss in government revenue by Area (C)

d.

With elimination of tariff, Gain or loss to the economy is equals to the sum of change in producer surplus, change in consumer surplus and change in government revenue.

Gain or loss to the economy= Area(A+B+C+D)-Area(A)-Area(C)= Area(B+D)

As there is a positive area (B+D) which is gained by the economy due a elimination of tariff.