Question

The Impact of Government Policy on Competitive Market

1. At the start of the COVID-19 pandemic, the Malay government temporarily eliminated import tariffs on disposable (single use) surgical masks. As a result, the domestic demand for disposable surgical masks were fulfilled by domestic production and imports. By July 2020, 99 million surgical masks valued at Rp400 billion were imported to Indonesia That same month, industry representatives asked the government to restore the import tariff on surgical masks. Assume that if the tariff is restored, there will still be import of surgical masks.

a. Explain the possible welfare impact of restoring the import tariff for surgical masks. Should the government impose an import quota instead? Explain your answer and use a graph to support your arguments.

Assume that the domestic demand for surgical mask in Malaysia (in million units) is Qd = 210 − 2P; the domestic supply in Malaysia (in million units) is Qs' = −100 + 600p; the world price is $0.40, and there are no barriers to trade. Calculate:
b. The quantity of domestic consumption, production, and import of masks!
c. The welfare impact of an import tariff of $0.05 per unit of surgical mask – explain in detail who gains, who loses, and by how much!

Answer 1

Answer:

(a) Import quota and import tariff is bith barriers on the free trade.

Import tariff levies tax on the quantity imported whereas import quota restricts the quantity imported.

The barriers on free trade increases producer surplus and generates government revenue and reduces consumer surplus.

If the objective of government policy is to increase domestic producers and protect domestic producers from foreign competition then import quota is better than import tariff.

.

(b) Quantity demanded = 209.8

Quantity supplied = 140

Quantity imported = 69.2

.

(c) Consumer surplus decreases by $10.4575

Producer surplus increases by $7.745

Government revenue = $1.955

.

Explanations:

(a) The imposition of tariff on surgical mask increases the world price of surgical mask paid by the consumers. As the price paid by consumer increases, the consumer losses but there are so many consumers in the economy so the individual loss to each consumer is very large. The price received by the producer increases so the producer surplus increases and as there are less producers in comparison to consumers, the individual gain to each producer is significant.

The government earns tax revenue and the tax revenue can be spent by the government to provide public goods and increase welfare of the economy.

Import quota results same as export tariff but the main difference is in import tariff government earns revenue whereas in import quota government may or may not earn revenue depending on how government is distributing license for imports.

If the goal of government is to balance the net exports then import quota is more effective but if it difficult to withdraw import quota compared to import tariff.

Each has its own benefits and dis-benefits it depends on the government from which objective they are levying the tariff or the quota.

If the objective is to promote domestic production then import quota is more beneficial.

.

(b) The given information is as follows:

Qd=210−2PQs=−100+600P

World price is $0.40

.

Quantity demanded at world price of $0.40 is:

Qd=210−2(0.40)=209.2

Quantity supplied at world price of $0.40 is:

Qs=−100+600(0.40)=140

.

The difference between quantity demanded and quantity supplied is quantity imported.

Quantity imported=Qd−QsQuantity imported=209.2−140Quantity imported=69.2

.

(c) After the imposition of tariff world price increases by $0.05

New world price = $0.40 + $0.05 = $0.45

.

Quantity demanded at world price of $0.45 is:

Qd=210−2(0.45)=209.1

Quantity supplied at world price of $0.45 is:

Qs=−100+600(0.45)=170

.

Quantity imported at new price is:

Quantity imported=Qd−QsQuantity imported=209.1−170Quantity imported=39.1

.

The consumer surplus is calculated as follows:

CS=21​(Pmax​−P)×Qd

Pmax is the price at which quantity demanded is 0:

Qd=210−2P0=210−2PPmax​=105

.

Consumer surplus at world price $0.40 is:

CS=21​(Pmax​−P)×QdCS=21​(105−0.40)×209.2CS=10,941.46

.

Consumer surplus at world price $0.45 is:

CS=21​(Pmax​−P)×QdCS=21​(105−0.45)×209.1CS=10,930.7025

.

The loss in consumer surplus is:

10,941.16−10,930.7025=10.4575

.

The producer surplus is calculated as follows:

PS=21​×(P−Pmin​)×Qs

Pmin is the price at which quantity supplied is 0:

Qs=−100+600P0=−100+600PPmin​=0.167

.

Producer surplus at price $0.40 is:

PS=21​×(P−Pmin​)×QsPS=21​×(0.40−0.167)×140PS=16.31

.

Producer surplus at price of $0.45 is:

PS=21​×(P−Pmin​)×QsPS=21​×(0.45−0.167)×170PS=24.055

.

Gain in producer surplus is:

24.055−16.31=7.745

.

Government revenue earned is:

Government revenue=Tariff×Quantity demandedGovernment revenue=$0.05×39.1Government revenue=$1.955

Therefore, loss in consumer welfare is 10.4575, gain in producer surplus is $7.745 and government revenue is $1.955.