Question

For a small open economy, the total welfare effect of imposing a tariff on imports is

A

always positive.

B

always negative.

C

always zero.

D

positive, negative, or zero.

Answer 1

Answer to the question is option B. always negative.

This is because :-

Importing Country Consumers - Consumers of the product in the importing country are worse-off as a result of the tariff. The increase in the domestic price of both imported goods and the domestic substitutes reduces consumer surplus in the market.

Importing Country Producers - Producers in the importing country are better-off as a result of the tariff. The increase in the price of their product increases producer surplus in the industry. The price increases also induces an increase in output of existing firms (and perhaps the addition of new firms), an increase in employment, and an increase in profit and/or payments to fixed costs.

Importing Country Government - The government receives tariff revenue as a result of the tariff. Who will benefit from the revenue depends on how the government spends it. These funds help support diverse government spending programs, therefore, someone within the country will be the likely recipient of these benefits.

Importing Country - The aggregate welfare effect for the country is found by summing the gains and losses to consumers, producers and the government. The net effect consists of two components: a negative production efficiency loss (B), and a negative consumption efficiency loss (D). The two losses together are typically referred to as "deadweight losses."

Because there are only negative elements in the national welfare change, the net national welfare effect of a tariff must be negative. This means that a tariff implemented by a "small" importing country must reduce national welfare.

In summary,

1) whenever a "small" country implements a tariff, national welfare falls.

2) the higher the tariff is set, the larger will be the loss in national welfare.

3) the tariff causes a redistribution of income. Producers and the recipients of government spending gain, while consumers lose.

4) because the country is assumed "small," the tariff has no effect upon the price in the rest of the world, therefore there are no welfare changes for producers or consumers there. Even though imports are reduced, the related reduction in exports by the rest of the world is assumed to be too small to have a noticeable impact.