Question

You have been asked to quantify the effects of removing a country's tariff on sugar. The hard part of the work is already done. Somebody has estimated how many pounds of sugar would be produced, consumed, and imported by the country if there were no sugar duty. You are given the information shown in the table.

Situation with import tariff estimated situation w/o tariff

World price $.10 per pound $.10 per pound

Tariff $.02 per pound $0

Domestic Price $0.12 per pound $0.10 per pound

Domestic consumption Billions of lb per year 20 22

Domestic Production billions of lb per year 8 6

Imports Billions of lbs per year 12 16

Calculate the following measures

a. The domestic consumers gain from removing the tariff.

b. The domestic producers loss from removing the tariff.

c. The government tariff revenue loss.

d. The net effect on national well being.

Please show how you calculate these. Thank you

Answer 1

Answer:

Given that

Effect of tariff can be calculated by use of a graph, as follows. In following graph, AB & CD are domestic demand & supply curves of the good.

Pre-trade equilibrium is at point E with price P1 & quantity Q1. With free trade, world price is P* (= $0.10) for which domestic consumption is Q2 (= 22 billion) and domestic production is Q3 (= 6 billion), therefore imports equal (Q2 - Q3) (= 22 - 6 = 16 billion).

Imposition of tariff will increase the price of the good, and domestic price rises to Pt (= $0.12), at which domestic consumption is Q4 (= 20 billion) and domestic production is Q5 (= 8 billion), therefore imports equal (Q4 - Q5) (= 20 - 8 = 12 billion). The tariff leads to a fall in import.

(a)

The domestic consumers gain from removing the tariff:

Consumer surplus (CS) = Area between demand curve and world price

CS after tariff = Area AHPt

CS before tariff = Area AFP* Gain in CS from tariff removal (Consumer gain) = Area PtHFP*

= (1/2) x $0.92 x (22 + 20) billion = $0.01 x 42 billion = $0.42 billion

= $420 million

(b)

The domestic producers loss from removing the tariff:

Producer surplus (PS) = Area between supply curve and world price

PS after tariff = Area CJPt

PS before tariff = Area CGP*

Loss in PS from tariff removal (producer loss) = Area PtJGP*

= (1/2) x $0.02 x (6 + 8) billion = $0.01 x 14 billion = $0.14 billion

= $140 million

(c)

The government tariff revenue loss:

Tariff revenue = Area JHLK = (Pt - P*) x (Q4 - Q5)

= $0.02 x 12 billion = $0.24 billion

= $240 million

(d)

The net effect on national well being:

Effect on national well-being is a deadweight (social inefficiency) loss (DWL). DWL = Area FHL + Area GJK = (1/2) x (Pt - P*) x [(Q2 - Q4) + (Q5 - Q3)] = (1/2) x $0.02 x [(22 - 20) + (8 - 6)] billion = $0.01 x (2 + 2) billion

= $0.01 x 4 billion

= $0.04 billion

= $40 million