Question

Suppose we have a large country that seeks to impose a tariff on products in the hopes of achieving a welfare gain as well as provide protection for its domestic industry. If the elasticity of export supply function is 0.04. First what is the optimal tariff that can be imposed that would provide for such welfare improvements? Second, in practice why might this country not find it optimal to implement this tariff?

Answer 1

The elasticity of supply function is , which is the percentage change in quantity dua to an increase in unit percentage of price. The optimal tariff (o) for a large nation can be computed as , and in this case, or percent. It will be the efficient tariff which will protect the domestic supply.

In practice, the country may not find it optimal to implement, due to the factor retaliation. Retaliation is a phenomena, which basically breaks the isolation of study of the domestic supply and import, and states that as one nation imposes tariff, however optimal or not, as it decreases the export of the exporting nation, they also raises their tariff to block the import of the first nation that imposed tariff. It happens as in the real world, the country that exports to a nation, also happens to be importing from that nation. Hence, retaliation causes raise in tariff of all the trading nations. Hence, this optimal tariff might raise the tariff of the nation from which the country in concern is importing, and decreases its export of any other good to that nation.