Question

Use the small country model. Suppose that Norway has a competitive disadvantage in producing lutefisk, so that when international trade is opened up, the world price for lutefisk is below the domestic (no-trade) price of lutefisk. Show the new price faced by Norwegians. Graphically show the reaction of Norwegian buyers and sellers of lutefisk to the change in price by identifying the new quantities purchased and sold. Does Norway export or import lutefisk?Identify that magnitude on the graph. Identify the change in consumer surplus and producer surplus. Does international trade increase or decrease total surplus for Norwegians?

*** NEED THIS ANSWER: Continuing the analysis from the question above.  Suppose that a tariff of magnitude t, less than that which would cut off all international trade, is imposed by the Norwegian government. Graphically show the effect on the price paid and received by Norwegians for lutefisk and show the reactions by identifying the new quantities purchased and sold. What happens to the level of lutefisk internationally traded (specifically, do exports or imports rise or fall)? Identify all the different elements of the change to total surplus. Does the imposition of the tariff increase or decrease total surplus for Norwegians?

Answer 1

Effect of tariff can be calculated by use of a graph, as follows.

In following graph, AB & CD are domestic demand and domestic supply curves of lutefisk. Autarkic equilibrium is at point E where AB intersects CD, with pre-trade price P1 and pre-trade quantity Q1. With free trade, world price is P* (< P1), at this price domestic demand is Q2 and domestic supply is Q3, hence imports equal (Q2 - Q3).

Free-trade Consumer surplus (CS) = Area between demand curve and world price = Area AFP*

Free-trade Producer surplus (PS) = Area between supply curve and world price = Area CGP*

The tariff will increase the domestic price, increasing it to Pt, at this price domestic demand is Q4 and domestic supply is Q5, so imports equal (Q4 - Q5). The tariff decreases imports, since (Q4 - Q5) < (Q2 - Q3).

After tariff, New CS = Area AHPt and new PS = Area CJPt.

Decrease in CS = Area PtHFP*, which is a loss to consumers.

Increase in PS = Area PtJGP*, which is a gain to producers.

Tariff revenue = Area PtHLP*, which is a (revenue) gain to the government.

Social inefficiency (deadweight) loss = Area FHL + Area GJK, therefore total surplus for Norwegians will decrease.