Question

(a) Home Market (b) Import Market Price Price Deadweight loss due to the tariffb+d S, S2 D2D Quantity Imports FIGURE 8-5 Effect of Tariff on Welfare The tariff increases the price from PW to pW+ t. As a result, consumer surplus falls by (a + b+ c+ ). Producer surplus rises by area a, and government revenue increases by the area c. Therefore, the net loss in welfare, the deadweight loss to Home, is (b + a), which is measured by the two triangles b and d in panel (a) or the single (combined) triangle b + d in panel 3. Consider a small country applying a tariff t to imports of a good like that represented in Figure 8-5. a. Suppose that the country decides to increase its tariff to t. Redraw the graphs for the Home and import markets and illustrate this change. What happens to the quantity of goods produced at Home and their price? What happens to the quantity of imports? b. Are there gains or losses to domestic consumer surplus due to the increase in tariff? Are there gains or losses to domestic producer surplus due to the increase in tariff? How is government revenue affected by the policy change? Illustrate these on your graphs. What is the overall gain or loss in welfare due to the policy change? c.

Answer 1

bl Impost mareet Peeice a) HomeCourtsuy Poure DwL 3 mposts

a) Quantity of goods produced at home increases from S₂ to S₃. Price will increase from P^w + t to P^w + t'. Imports will fall with increase in tariff.

New imports = D₃ - S₃

b) Consumer surplus falls by area (M + N + O + P)

Producer surplus increases by area M.

Government revenue increases by area O.

c) Overall loss in welfare due to policy is area (O + C).