Question

Data of a perfect competition market for good X is given by the following supply and
demand equation:
(D) : P = -1/2*Q + 600
(S): P = 1/2*Q + 350
The world price; Pw = 450$
Assume that the country is small and there is free trade.
a. Calculate the imported amount of good X, domestic quantity supplied and quantity
demanded at the world price.
b. Now the government imposes a tax of t = 10$/ imported unit, identify the effect of
tariff on the importing country in terms of: domestic production, domestic demand,
domestic price.
c. Calculate the Deadweight Loss caused by the tariff policy.
d. Explain why even the tariff policy causes a Deadweight Loss to the society, many
developing countries still use it.
e. If the Vietnamese government increases its tariff on the imported rice from Thailand
and Japan, what will be its effects on the market for rice in Vietnam?

Answer 1

a) Domestic quantity supplied at world price:-

450=1/2*Q + 350

Qs=200

Domestic quantity demanded at world price:-

450= -1/2*Q + 600

Qd=300

Imported amount of good X = 300-200= 100 units

b) Now after tax, the world price becomes $460

Domestic quantity supplied at world price:-

460=1/2*Q + 350

Qs= 220 (domestic supply)

Domestic quantity demanded at world price:-

460=-1/2*Q + 600

Qd=280 (domestic demand)

Domestic Price= World price= $460

c) Deadweight loss due to taxation= 1/2*(P1-P0)*(Q1-Q0)

=1/2*20*10= $100

d) Some of the reasons why tariffs are imposed even if it leads to deadweight loss are:

1) To protect newly established domestic industries from foreign competition

2) To protect domestic producers from dumping(if a foreign company charges a price which is below the domestic production cost) by foreign companies or governments.

3) To raise revenue, eg tariffs on import of oil helps many developed countries to raise revenue.

e) The market for rise will fall due to deadweight loss.