Question

Exercise 1: Tariffs and Elasticity

A country imports 5 billion tonnes of coal per year and domestically produces another 4.5 billion tonnes of coal per year. The world price of coal is $50 per tonne. Assuming linear schedules, economists estimate the price elasticity of domestic supply to be 0.3 and the price elasticity of domestic demand to be 0.2 at the current equilibrium. Consider the changes in social surplus that would result from imposition of a $20 per tonne import fee on coal that would involve annual administrative costs of $125 million. Assume that the world price will not change as a result of the country imposing the import fee, but that the domestic price will increase by $20 per tonne. Assume national standing. Calculate the following:

(a) Quantity consumed after the imposition of the import fee.

(b) Quantity produced after the imposition of the import fee.

(c) Quantity imported after the imposition of the import fee.

(d) Estimate the annual social net benefits of the import fee.

Answer 1

Thus, after imposition of the fee, domestic consumption will fall to 9.5-0.76=8.74 billion tonnes per year, domestic production will rise to 4.5+0.54=5.04 billion tonnes per year, and imports will fall to 8.74 - 5.04 = 3.7 billion tonnes per year. In order to find the change in total surplus I first draw the diagram representing the situation and the social accounting ledger.

Notice that the net benefit of this policy is clearly negative and this will reflect in the CBA. The tari↵ received by the government are merely a transfer from consumers to the govt. Similarly the increased profits of domestic growers is a transfer from the consumers to the producers. The changes in total surplus is given by

-(K+L+admin fees) = (0.5 ⇥ 0.76 ⇥ 20 + 0.5 ⇥ 0.54 ⇥ 20 + 0.125) = 13.125billion