Question

A small country trades food and clothing on world markets at prices pc and pf (these prices are fixed from the point of view of the small country). This country produces both goods (clothing with capital and labor; food with land and labor) and imports food. Capital and land are fixed factors while labor can move between sectors. Policy makers are considering the imposition of a 10% tariff on food (this tariff would raise the price of food in the country by 10% and would not affect the price of clothing). All workers, capital owners, and land owners share the same homothetic preferences.

1. What will be the effect of this tariff on the returns to all 3 factors (w,rk, rr)? If these returns increase, be sure to specify whether they will increase by more or less than the tariff (i.e. whether they will increase by more or less than 10%).

2. Use your answer to part (a) to predict whether each factor will have any incentives to lobby the policy makers for protection (the imposition of the tariff).

Answer 1

1. Food being an essential commodity and being imposed and tarriff of 10% it will sightly affect the demand. As the import is being discouraged here then the focus on home production would increase and to suffice the gross demand for the food in small country,. Hence it demand for labour in food production sector shall increase or if the number of labours involved in the food production doesn't increase that much, they have to produce more sleep, so in a way return on labour employed would increase.

Now, if the amount produced on same piece of land increase then definitely the rate of return on land would increase too.

However the return on capital would remain unchanged as the capital production of the food doesn't involve capital.  

The aggregated return on the factors will be less than 10% or else the the costing of food production will be at par with the price of the food being import post tarriff ( 10% hike) .

2. From above explanations it can be clearly understood that the imposition of tariff has made a positive impact on the home production of food and the return on the factor of production has increased as well. So, expectedly the the land owner and the workers will have the incentive to support protection by imposing duty on import.