Question

Construct a diagram showing the effect of placing a tariff on an import when the country is large. Draw your diagram so that clearly and unambiguously the tariff decreases national welfare. Explain your diagram.

Answer 1

When tariff is imposed on a large importing country, assuming D is the original demand curve and S is the supply curve. Pf is the free trade equilibrium.

The new price after the imposition of tariff rises to Pt and the price for the exporting country falls to P*,

Consumers in the importing country suffer a reduction in well-being as a result of tariff. The increase in domestic prices reduces the consumer surplus by the area (A+B+C+D).

On the other hand, producers experience a gain in well being as the producer surplus increases by the area A.

The government receives tariff revenue as a result of tariff - equiuvalent to area C + G in the above diagram.

Thus, total national welfare = G - (B+D)

Because there are both positive and negative elements, the net national welfare effect can be either positive or negative. However, as is visible from the above diagra, area B + D > area G. Hence, the net effect is negative in this case, thus decreasing national welfare