Price of Steel. Domestic Supply. C 10 World G. Price Domestic Demand. Quantity of Steel HOMEWORK 4 TARIFFS ECO41 FALL 2014 UDAYAN ROY

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1 HOMEWORK 4 TARIFFS ECO41 FALL 2014 UDAYAN ROY Each correct answer is worth 1 point. The maximum score is 20 points. This homework is due on Wednesday, October 1, in class. Please show your answers on the answer sheet (on the last page). 1. When, in our analysis of international trade, we assume that a country is small, we are in effect assuming that the country a. is too small to experience significant gains or losses from its trade with other countries b. does not have a significant comparative advantage over other countries c. is such that events within that country do not have any effect on world prices of traded goods d. has fewer than 10 million people 2. A tax on an imported good is called a a. Quota b. Tariff c. Subsidy d. Protectionism Price of Steel Domestic Supply A 14 B C D E F 10 World G Price Domestic Demand Quantity of Steel

2 Use the above diagram of the steel market in a small country for all the questions that follow. Questions 3-8 are about a government that allows free trade but simultaneously imposes a $4 per unit consumption tax on domestic buyers of steel and a $4 per unit production subsidy for domestic producers of steel. Let us call this the tax-plus-subsidy policy. 3. Then, under the tax-plus-subsidy policy, the tax-included price paid by buyers of steel is $ and the subsidy-included price received by domestic producers of steel is $. 4. Under the tax-plus-subsidy policy, the quantity of steel consumed domestically is, the quantity of steel produced domestically is, and the quantity of steel imported is. 5. Starting from free trade without government intervention, when the tax-plus-subsidy policy is imposed, the consumer surplus: a. Increases by AB b. Decreases by AB c. Increases by CDEF d. Decreases by CDEF 6. Starting from free trade without government intervention, when the tax-plus-subsidy policy is imposed, the producer surplus: a. Increases by C b. Decreases by C c. Increases by CD d. Increases by CDEF 7. Under the tax-plus-subsidy policy, the government will earn revenue from the tax, but will have to spend money on the subsidy. Let net revenue = revenue from the consumption tax expenditure on the production subsidy. This net revenue is $. (Just write down an amount to the nearest dollar. For example, if you think the tariff revenue is $510.30, enter 510 as your answer.) This amount can also be indicated by the area (using the letters A through G). 8. The deadweight loss caused by the tax-plus-subsidy policy is. (Enter any combination of the letters A through G in alphabetical order and without spaces. If you think a tariff does not have any deadweight loss, please enter 0 as your answer.) For questions 9-14 assume that the government of the small country shown in the diagram on the first page allows trade in steel but imposes a $4 per unit tariff on imported steel. 9. Under free trade the price of steel is $. After a $4 per unit tariff is imposed on imported steel, the price of domestically produced steel is $ and the price of imported steel is $. 2

3 10. After a $4 per unit tariff is imposed on imported steel, the quantity of steel consumed domestically is, the quantity of steel produced domestically is, and the quantity of steel imported is. (Indicate the quantities.) 11. Starting from free trade, when a $4 per unit tariff is imposed on imported steel, consumer surplus: a. Increases by AB b. Decreases by AB c. Increases by CDEF d. Decreases by CDEF 12. Starting from free trade, when a $4 per unit tariff is imposed on imported steel, producer surplus: a. Increases by C b. Decreases by C c. Increases by CD d. Increases by CDEF 13. When a $4 per unit tariff is imposed on imported steel, the government s revenue from the tariff is $. This amount can also be indicated by the area. (Enter any combination of the letters A through G in alphabetical order.) 14. When a $4 per unit tariff is imposed on imported steel, its deadweight loss is. (Enter any combination of the letters A through G in alphabetical order and without spaces. If you think a tariff does not have any deadweight loss, please enter 0 as your answer.) The next two questions compare the tax-plus-subsidy policy of questions 3-8 above with the import tariff of questions 9-14 above. 15. Compared to the tax-plus-subsidy policy, the quantity of steel consumed domestically is under the tariff, the quantity of steel produced domestically is under the tariff, and the quantity of steel imported is under the tariff. a. Higher; Lower; Higher b. Lower; Higher; Lower c. The two policies have identical effects d. Higher; Higher; Higher e. Lower; Lower; Lower 16. Compared to the tax-plus-subsidy policy, consumer surplus is under the tariff, producer surplus is under the tariff, and deadweight loss is under the tariff. a. Higher; Lower; Higher b. Lower; Higher; Lower c. The two policies have identical effects 3

4 d. Higher; Higher; Higher e. Lower; Lower; Lower The remaining questions compare a production subsidy of $4 per unit on domestically produced steel with a tariff of $4 per unit on imported steel. (As before, assume a small country represented by the diagram on the first page, and assume that trade is allowed.) 17. Let us compare two policies: (a) a production subsidy of $4 per unit on domestically produced steel and (b) a tariff of $4 per unit on imported steel. The amount of steel produced is under the production subsidy and under the tariff. (Enter at most 2 digits as your answer in each blank.) 18. Let us compare two policies: (a) a production subsidy of $4 per unit on domestically produced steel and (b) a tariff of $4 per unit on imported steel. Producer surplus is under the production subsidy and under the tariff. (Enter combinations of the letters A through G, in alphabetical order and without spaces, as your answer in each blank.) 19. Suppose the President says, A tariff on imported steel increases the domestic production of steel and thereby creates jobs in our steel industry. Yes, I know that a tariff has a negative overall effect on the nation s total welfare. Nevertheless, for political reasons, I must give higher priority to job creation. Therefore, I will impose a tariff on imported steel. If you were the President's adviser, which of the following replies would be the best? a. As usual, Mr. President, you are so right! I can t believe how brilliant you are! b. Mr. President, keeping the steel industry happy is crucial for your political survival. Therefore, your best policy is to impose a tariff on imported steel. c. Mr. President, keeping the steel industry happy is crucial for your political survival. Nevertheless, a production subsidy to domestic steel producers would keep them just as happy as a tariff on imported steel would. In addition, the deadweight loss of the subsidy would be less than the deadweight loss of the tariff. Therefore, you would do better to use a subsidy instead of a tariff, whether you are thinking only about your re-election prospects or about the nation's welfare. d. Mr. President, keeping the steel industry happy is crucial for your political survival. Nevertheless, a tax on domestic consumers of steel would keep the steel industry just as happy as a tariff on imported steel would and, in addition, the deadweight loss of the tax would be less than the deadweight loss of the tariff. Therefore, you would do better to use a tax instead of a tariff. 20. A tariff a production subsidy given to producers in the import-competing industry because, while both policies can help producers in the import-competing sector, needlessly imposes additional burdens on domestic consumers a. Is superior to; the subsidy b. Is inferior to; the subsidy c. Is inferior to; the tariff d. Is just as good as; neither the tariff nor the subsidy 4

5 ANSWER SHEET HOMEWORK 4 (Tariffs) ECO41 FALL 2014 UDAYAN ROY NAME: DATE: