Question

. Show and explain the large nation case of Country 1, which initially has a tariff on its imports of Good Z and later eliminates its tariff on Good Z.

(a) For Country 1 graphically show and label the change in (i) domestic producer surplus, (ii) domestic consumer surplus, (iii) domestic government tax revenue, and (v) domestic net total change. [Use a large graph!]

(b) What happens to the net import price of Good Z for Country 1 given the change in the tariff?

What happens to the domestic terms of trade effect area for Country 1 as a result?

Answer 1

a).

Consider the following fig.

So, here “D” be the demand and “S” be the supply curve. Now, initially a tariff of amount “t” was imposed, => the home price and the foreign price under tariff is given by, “P1”and “P2” respectively, where “P1-P2=t”. Now, at “P=P1” the corresponding demand and supply are given by “D1” and “S1”. Now, if the tariff is eliminated, => the world price is given by “Pw” in both the country, => as the “P” decreases from “P1” to “Pw”, => the consumer surplus increases by the area “a+b+c+d” and the producer surplus decreases by “a”. Now, initially the government’s tariff revenue was “c+e”, now under free trade it reduces to “0”. So, the “net change in the welfare” is given by.

=> dW = d(CS) + d(PS) + d(tariff revenue), => dW = (a+b+c+d) + (-a) + (-c-e) , => dW = (b + d) + (-e).

=> dW = (b+d-e).

b).

As the tariff eliminated implied the import price decrease from “P1” to “Pw”. Now, the terms of trade area is given by “b+d-e”. Now, because it is a large country, => for a large country the terms of trade effect is positive of a tariff. So, here as the tariff decreases TOT effect is negative, => “b+d-e < 0”.