Question

1. 

2. Assume Thailand and India are potential trading partners of China. Thailand is a member of ASEAN but India is not. Suppose the import price of textiles from India (pIndia) is 50 per unit under free trade and is subject to a 20% tariff by China. As of January 1, 2010, China and Thailand entered into the China–ASEAN free-trade area, eliminating tariffs on imports from Thailand. The following figure shows China’s import demand curve and the export supply curves of its two trading partners. Note that Thailand cannot fulfill all of China’s import demand at the indicated world prices.

1. What do the export supply curves for Thailand and India imply about their relative size compared to China in the world textile market?

2. Before the China–ASEAN free-trade area, how much does China import from each trading partner (assuming China buys from both)? What is the import price? Calculate the tariff revenue earned by China’s government.

3. After the China–ASEAN free-trade area, how much does China import from each trade partner? What is the import price? What is total tariff revenue for China?

4. Based on your answers above, what is the net welfare impact of the China–ASEAN free-trade area on China’s welfare? Does the trade pact generate trade creation or trade diversion overall?

5. What is the impact of the China–ASEAN free-trade area on the welfare of Thailand and of India?

6. The China-ASEAN agreement may lead to a similar one between China and India. How would this affect China’s imports from each country? What would be the effect on welfare in China, Thailand, and India if such an agreement were signed?

Price SThailand + t Sthailand 60 = PIndia +t 50 = PIndia 'Mchina 40 10 60 70 Import quantity Feenstra Taylor, International Economics, 4e, © 2017 by Worth Publishers

Answer 1

a. What do the export supply curves for Thailand and India imply about their relative size compared to China in the world textile market?

The supply curve of India is horizontal, that is, perfectly elastic. It implies it can supply infinite units at a price. The supply curve of Thailand is upward sloping, that is, more will be supplied only at higher prices. Therefore, India's relative size compared to China in the world textile market is big whereas that of Thailand is small.

b. Before the China–ASEAN free-trade area, how much does China import from each trading partner (assuming China buys from both)? What is the import price? Calculate the tariff revenue earned by China’s government.

China imports 10 units from Thailand and 50 units from India. The tariff-inclusive price is 60 and the net-of-tariff price is 50. The tariff revenue is 600 ($10 tariff x 60 units).

c. After the China–ASEAN free-trade area, how much does China import from each trade partner? What is the import price? What is total tariff revenue for China?

After the China-ASEAN free-trade agreement, the relevant supply curve for Thailand is SThai because it is able to sell to China duty-free. Without the tariff, imports from Thailand increase to 40 units with price remaining constant at PIndia+ t. Price is unchanged because the rise in production results from increasing marginal costs as given along Thailand’s supply curve. Although China continues to import from India, the amount purchased has decreased to 20 units.The total tariff revenue of China is now 200 ($10 tarif x 20 units).

d. Based on your answer to part (b), what is the impact of the China-ASEAN free-trade area on the welfare of China? Does the trade pact generate trade creation or trade diversion overall?

China is paying the same import price as before, but has lost the tariff revenue on the 30 units that it used to import from India and now imports from Thailand. In addition, it loses the tariff revenue on the 10 units that it imported from Thailand all along, so the total loss is (a+ b+ c) = 400.Therefore, China is worse off due to this trade diversion.

e. What is the effect of the China-ASEAN free-trade area on the welfare of Thailand and India?

India is selling less, but because it still receives the same price as before (50 net of the tariff), we cannot calculate any loss. Thailand has a rise in producer surplus of the amount (a + b) due to selling more to China, so Thailand is better off.

f. The China-ASEAN agreement may lead to a similar one between China and India. How would this affect China’s imports from each country? What would be the effect on welfare in China, Thailand, and India if such an agreement were signed?

If a similar tariff free agreement is signed between India and China, the price = 50 would prevail. China's imports from Thailand will now decrease to 10 units and imports from India will rise to 60 units. China will lose all its tariff revenue now and its total imports will increase from 60 units to 70 units. Exports of Thailand will decrease and exports of India will increase. Thus Thailand and China will be worse off but India will be better off.