Question

Consider the following scenario. Suppose that the free-trade price of a ton of steel is €500. Finland, a small country, imposes a €60-per-ton specific tariff on imported steel. With the tariff, Finland produces 300,000 tons of steel and consumes 600,000 tons of steel. As compared with free trade, steel production has risen by ½ while steel consumption fallen by 1/7.

(1) Draw a picture of Finland’s domestic market to illustrate this scenario. Please label all prices and quantities under free-trade and under the tariff.

(2). The tariff makes Finnish steel producers better off.

(3). The tariff makes Finnish steel consumers better off.

Answer 1

(1)

Before tariff,

Domestic consumption = 600,000 x (7/6) = 700,000

Domestic production = 300,000 x (2/3) = 200,000

In following graph, D0 and S0 are domestic demand and supply curves. Free trade price is Pw (= 500) at which domestic consumption is Q1 (= 700,000) and domestic production is Q2 (= 200,000), therefore imports equal (Q1 - Q2) (= 700,000 - 200,000 = 500,000). After tariff, price rises by 60 to (500 + 60) = 560, at which domestic consumption falls to Q3 (= 600,000) and domestic production rises to Q4 (= 300,000), therefore imports fall to (Q3 - Q4) (= 600,000 - 300,000 = 300,000).

(2) True.

After tariff, producer surplus (PS) increases. Since PS is the area between supply curve and market price,

Increase in PS = Area PwCDPt = (1/2) x 60 x [(200,000 + 300,000)]** = 30 x 500,000 = 15,000,000

So, the tariff makes Finnish steel producers better off by 15,000,000.

(3) False.

After tariff, consumer surplus (CS) decreases. Since CS is the area between demand curve and market price,

Decrease in CS = Area PwBAPt = (1/2) x 60 x [(700,000 + 600,000)]** = 30 x 1,300,000 = 39,000,000

So, the tariff makes Finnish steel consumers worse off by 39,000,000.