Question

Consider a large country that imports good R. Some of the total quantity of R domestically consumed is supplied by domestic producers and the rest of it is imported. Then suppose that the government imposed a tariff on each unit of R that is imported, so that the quantity of R imported is somewhat reduced. Draw a demand and supply diagram that shows the effect of the tariff. On your diagram, 4 of 4 shade-in the area that represents the government revenue from the tariff which is in effect being paid by foreign exporters (please do not shade-in any other areas). Then provide an explanation for why this area represents the government revenue from the tariff which is in effect being paid by foreign exporters. (10 Marks, maximum word limit: 100 words

Answer 1

In the diagram above, we have shown the demand and supply for R of a large country. Let world supply of R be perfectly price elastic. At world price P, the country was domestically producing Q₁ units of R and importing (Q₄-Q₁) units of R.

Now with a tariff of say $t per unit of import of R, the new price increases to P' (P+$t). At this price, domestic producers increases their production from Q₁ to Q₂, and level of imports falls from (Q₄-Q₁) units of R to (Q₃-Q₂) units of R. Thus, domestic production increases and level of imports falls.

As a result, due to tariff, consumer surplus falls whereas, producer surplus rises. Again, with tariff, government earns some revenue equal to tariff $t * level of imports (Q₃-Q₂) units of R from the foreign exporters. The government revenue earned is shown in the diagram above.