Homework (Ch 04)

1. Identifying types of tariffs

For each hypothetical scenario, complete the first column in the following table by indicating whether the tariff described is more likely a protective tariff or a revenue tariff.

Scenario	Protective or Revenue	Tariff Type
A. In response to concerns from business leaders, a legislator has designed a new tariff on raw materials used by many manufacturing firms. The legislator felt the new tariff was necessary based on input from the private sector that new discoveries of natural resources abroad would threaten to put domestic producers of raw materials out of business. To meet this goal, this tariff will charge $1,500 on every crate of the imported goods plus an additional 5% of the total value of the imported goods.	Protective	Compound
B. A member of Congress introduced legislation to create a new tariff. He wants to use the revenue collected from it to help pay down the national deficit. To meet this goal, this tariff will charge $1,500 on every ton that is imported.	Revenue	Specific

Points:

1 / 1

Economists classify tariffs as either a protective tariff or a revenue tariff, depending on the goal. Protective tariffs are designed to limit the amount of a good that is imported into a country, thus giving domestic producers of the same good an advantage in the domestic market because their goods do not face a cost that the imported ones do. Because the goal of the tariff presented in scenario A is to protect the domestic raw materials industry from increased competition (by making imported raw materials more expensive), this is an example of a protective tariff.

Revenue tariffs can be placed on imported or exported goods. Although they will reduce the amount of the good that is traded, the primary intent of this kind of tariff is to generate tax revenue for the government that imposes the tariff. Because the goal of the tariff presented in scenario B is to increase revenue (that would be used to reduce the deficit), this is an example of a revenue tariff.

For each hypothetical scenario, complete the second column in the previous table by determining if the fees charged represent an ad valorem, compound, or specific tariff.

You can calculate the amount of money an importer pays as a tariff in three different ways:

•	Ad valorem tariffs are calculated based on the total value of the imported goods. Regardless of the number of units imported, the size of an ad valorem tariff is based on a percentage of the total value of all the goods imported.
•	Specific tariffs charge a set fee per unit. So, for every unit imported, the government charges a specific amount of money.
•	Compound tariffs are a combination of a specific and an ad valorem tariff. They charge both a per-unit fee and a percentage of the total value of the goods.

In this case, scenario A represents a compound tariff, because the amount of the tariff depends on both how many units are imported and the total value of those units; and scenario B represents a specific tariff, because the amount of the tariff is based on only the number of tons imported and does not depend on the total value of the imports.

2. Calculating the effective rate of protection

CompuGlobal is an American firm producing computers. CompuGlobal imports computer components from Taiwan and assembles them domestically. Suppose that in the United States, a computer sells for $300 and that 80% of the computer’s value comes from the value of the imported components. The United States imposes a 30% tariff on computers and a 10% tariff on the computer’s components. Assume that costs of producing components are the same in the United States and Taiwan and that transit costs are nonexistent.

Based on the information provided, the effective rate of protection that CompuGlobal receives from the tariff is110% .

Points:

1 / 1

When a company imports components for a finished good but assembles them domestically, it may face an effective tariff rate that differs from the nominal tariff rate (the tariff rate on the finished good that is published in the domestic country’s tariff schedule). In this case, the nominal tariff rate is the one that the United States imposes on computers, which is 30%. The effective tariff rate that CompuGlobal faces is a measure of how protected a product’s market is, based on the tariffs on both final goods and imported components. The effective rate of protection,

e

, is calculated using the following formula:

e

=

\frac{n - ab}{1 - a}

In this equation,

n

stands for nominal tariff on the final good,

b

is nominal tariff on the imported components, and

a

denotes the ratio of the value of the imported components to the value of the final good. The effective rate of protection, therefore, is as follows:

$e$	$=$	$\frac{n - ab}{1 - a}$
	$=$	$\frac{0.3 - 0.8 \times 0.1}{1 - 0.8}$
	$=$	$1.1, or 110%$

Note that the effective rate can be higher or lower than the nominal rate (and even negative). If the effective rate on a good is lower than the nominal rate, the government’s policy does more to protect domestic producers of components than final goods. Similarly, if the effective rate is higher than the nominal rate, then the government’s policy favors domestic producers of finished goods over domestic suppliers of raw materials. It is more common to see an effective rate that is higher than the nominal rate. Such a policy is known as tariff escalation.

3. Winners and losers from tariff reductions

Suppose that Canada imports pearl necklaces from India. The free market price is $80.00 per necklace.

If the tariff on imports in Canada is initially 8%, Canadians pay

$86.40

per necklace.

Points:

1 / 1

With the 8% tariff, you can calculate the price Canadians pay for Indian pearl necklaces in the following way:

$Price for Canadian Consumers$	$=$	$Free Trade Price + (Tariff \times Free Trade Price)$
	$=$	$Free Trade Price \times (1 + Tariff)$
	$=$	$$80.00 per necklace \times (1 + 0.08)$
	$=$	$$86.40 per necklace$

One of the accomplishments of the Uruguay Round that took place between 1986 and 1993 was significant across-the-board tariff cuts for industrial countries, as well as many developing countries. Suppose that as a result of the Uruguay Round, Canada reduces its import tariffs to 4%.

Assuming the price of pearl necklaces is still $80.00 per necklace, consumers now pay the price of

$83.20

per necklace.

Points:

1 / 1

With the 4% tariff, you can calculate the price Canadians pay for Indian pearl necklaces in the following way:

$Price for Canadian Consumers$	$=$	$Free Trade Price + (Tariff \times Free Trade Price)$
	$=$	$Free Trade Price \times (1 + Tariff)$
	$=$	$$80.00 per necklace \times (1 + 0.04)$
	$=$	$$83.20 per necklace$

Based on the calculations and the scenarios presented, the Uruguay Round most likelyhurts producers in Canada andbenefits producers in India.

Points:

1 / 1

The reduction of the import tariff in Canada to 4% benefits Canadian consumers, as the price of imports falls from $86.40 to $83.20 per necklace. However, the lower tariff hurts Canadian producers as they face a stronger competition with foreign producers. At the same time, producers in India also benefit from the lower tariffs because they can more easily export their product by selling at a lower price.

4. Tariff effects: An overview

Consider two hypothetical countries, Borzia and Ardon. Both countries produce iDevices, and the price of iDevices is higher in Borzia than in Ardon. If Borzia and Ardon open to trade, producers inBorzia would be more likely to lobby their government for an import tariff on iDevices in order to protect themselves from foreign competition.

Points:

1 / 1

Since the price of iDevices in Borzia is higher than in Ardon, producers in Borzia are unable to stay competitive under free trade, whereas producers in Ardon are able to stay competitive. Therefore, producers in Borzia are more likely to lobby for an import tariff on iDevices.

Which of the following statements about the effects of the tariff compared to free trade are correct? Check all that apply.

In Borzia, consumers pay more for the domestic iDevices.

In Ardon, workers in iDevice importing companies lose their jobs.

In Borzia, some workers at retail and shipping companies that import iDevices lose their jobs.

In Borzia, workers in iDevice importing companies see more jobs available to them.

In Borzia, producers of iDevices are willing to expand output.

Points:

1 / 1

The purpose of a tariff is to reduce the price differential between trading countries. As a result of the tariff, consumers in Borzia will pay more for their protected domestic iDevices. Producers are always willing to expand production if a tariff provides them with new protection because that tariff will drive up the domestic price. Although producers in Borzia will benefit from the tariff, some workers in retail and shipping companies that import iDevices will lose their jobs.

5. Effects of a tariff on international trade

The following graph shows the domestic supply of and demand for wheat in Bolivia. Bolivia is open to international trade of wheat without any restrictions. The world price (

P_{W}

) of wheat is $245 per bushel and is represented by the horizontal black line. Throughout this problem, assume that the amount demanded by any one country does not affect the world price of wheat and that there are no transportation or transaction costs associated with international trade in wheat. Also, assume that domestic suppliers will satisfy domestic demand as much as possible before any exporting or importing takes place.

Use the graph input tool to help you answer the following questions. You will not be graded on any changes you make to this graph.

Note: Once you enter a value in a white field, the graph and any corresponding amounts in each grey field will change accordingly.

Graph Input Tool

Market for Wheat in Bolivia
Price (Dollars per bushel)
Domestic Demand (Thousands of bushels of wheat)		Domestic Supply (Thousands of bushels of wheat)

If Bolivia is open to international trade of wheat without any restrictions, it will import

360,000

bushels of wheat. (Note: Be sure to enter the full value for your answer, accounting for the horizontal axis units.)

Points:

0 / 1

At the current world price of $245 per bushel, Bolivia’s domestic demand for wheat is 360,000 bushels, but it will domestically produce only 40,000 bushels of wheat. Bolivia will import the difference of 320,000 bushels of wheat.

Suppose the Bolivian government wants to reduce imports to exactly 160,000 bushels of wheat to help domestic producers. A tariff of

$40

per bushel will achieve this.

Points:

1 / 1

To reduce imports to 160,000 bushels of wheat, the government must set a tariff that will raise the price of wheat to the point where domestic demand exceeds domestic supply by exactly 160,000 bushels of wheat.

A $40-per-bushel tariff on wheat would raise the domestic price of wheat to $285 ($40 per bushel higher than the world price of $245). At a price of $285 per bushel, domestic demand will be 280,000 bushels, and domestic supply will be 120,000 bushels of wheat. Bolivia will import the difference of 160,000 bushels of wheat.

A tariff set at this level would raise

$6,400,000

in revenue for the Bolivian government.

Points:

1 / 1

A $40-per-bushel tariff on wheat would cause Bolivia to import 160,000 bushels of wheat. Therefore, you can compute the amount of tax revenue this tariff will generate in the following way:

$Tax Revenue$	$=$	$Specific Tariff \times Quantity Imported$
	$=$	$$40 per bushel \times 160,000 bushels$
	$=$	$$6,400,000$

6. Effects of a tariff in a small nation

Suppose Sudan is open to free trade in the world market for maize. Because of Sudan’s small size, the demand for and supply of maize in Sudan do not affect the world price. The following graph shows the domestic maize market in Sudan. The world price of maize is

P_{W} = $350

per ton. Throughout this problem, assume that changes in trade policies in other nations do not significantly affect the world market for maize and that there are no transportation or transaction costs associated with international trade in maize. Also assume that domestic supplies will satisfy domestic demand as much as possible before any exporting or importing takes place.

On the following graph, use the green triangle (triangle symbols) to shade the area representing consumer surplus (CS) when the economy is at the free-trade equilibrium. Then, use the purple triangle (diamond symbols) to shade the area representing domestic producer surplus (PS).

Points:

1 / 1

Consumer surplus is the difference between a buyer’s willingness to pay and the price the buyer actually pays. Graphically, consumer surplus is the area above the world price of $350 per ton, below the domestic demand curve, and to the left of the quantity of maize demanded at a price of $350.

Producer surplus is the difference between the price a seller actually receives for an item and the lowest price at which the seller would be willing to provide the item. Graphically, domestic producer surplus is the area below the world price of $350 per ton, above the domestic supply curve, and to the left of the quantity of maize supplied by domestic producers at a price of $350.

If Sudan allows international trade in the market for maize, it will import

24,000

tons of maize. (Note: Be sure to enter the full value for your answer, accounting for the horizontal axis units.)

Points:

1 / 1

With international trade, the price of maize in Sudan will equal the world price of $350 per ton. At this price, 27,000 tons of maize will be demanded in Sudan, but domestic producers will supply only 3,000 tons at the world price. The difference of 24,000 tons is the quantity of maize Sudan will import.

You can also derive this result graphically:

Now suppose the Sudanese government decides to impose a tariff of $40 on each imported ton of maize. After the tariff, the domestic price of a ton of maize will be

$390

, and Sudan will import

18,000

tons of maize.

Points:

1 / 1

Since Sudan’s economy is not large enough to affect the world market for maize, the tariff does not affect the world price of maize. Therefore, a tariff of $40 raises the price Sudanese consumers pay for each imported ton of maize from $350 to $390. This means that domestic suppliers can also sell their maize for $390 per ton. Therefore, the price of a ton of maize in Sudan, either imported or domestically produced, rises to $390.

At a price of $390, domestic demand will be 24,000 tons of maize, and domestic supply will be 6,000 tons. The difference, 18,000 tons, is the quantity of maize Sudan will import when a tariff of $40 is imposed.

Show the effects of the $40 tariff on the following graph.

Use the grey line (star symbol) to indicate the world price plus the tariff. Then, use the green triangle (triangle symbols) to show the consumer surplus with the tariff and the purple triangle (diamond symbols) to show the domestic producer surplus with the tariff. Lastly, use the orange quadrilateral (square symbols) to shade the area representing government revenue received from the tariff and the tan triangles (dash symbols) to shade the areas representing the net loss or deadweight loss (DWL) caused by the tariff.

Points:

1 / 1

With the tariff, the domestic price of a ton of maize is $390, and 18,000 tons of maize are imported into Sudan.

The following graph summarizes the welfare effects of the tariff:

Graphically, with a tariff of $40, consumer surplus is the area above the price of $390 per ton, below the domestic demand curve, and to the left of the quantity of maize demanded at a price of $390. This is represented by area A on the accompanying graph. Because consumer surplus with no trade restrictions was the area above the world price of $350 per ton, below the demand curve, and to the left of the quantity of maize demanded at a price of $350 (areas A, B, C, D, and E), the tariff reduces consumer surplus by the area between $350 per ton and $390 per ton and below the demand curve (areas B, C, D, and E).

Graphically, with a tariff of $40, domestic producer surplus is the area below the domestic price of $390, above the domestic supply curve, and to the left of the quantity of maize supplied by domestic producers at a price of $390. This is represented by areas B and F. Because domestic producer surplus with no trade restrictions was the area below the world price of $350 per ton, above the supply curve, and to the left of the quantity of maize supplied at a price of $350 (area F), the tariff increases domestic producer surplus by the area between $350 per ton and $390 per ton and above the supply curve (area B). This transfer of the consumer surplus in monetary terms to the domestic producers of maize is known as the tariff’s redistributive effect.

The government collects $40 on every ton of imported maize; this is known as the tariff’s revenue effect. Because 18,000 tons of maize are imported once the tariff is imposed, the government receives a revenue of

$40 per ton \times 18,000 tons of maize = $720,000

. This corresponds to area D.

With free trade, consumer surplus was equal to areas

A + B + C + D + E

, producer surplus was equal to area F, and government revenue was zero. Thus, total surplus was equal to areas

A + B + C + D + E + F

. With the tariff, consumer surplus is equal to area A, producer surplus is equal to areas

B + F

, and government revenue is equal to area D. With the tariff, nobody receives the welfare associated with areas C and E, so those are considered the net loss or deadweight loss. More specifically, the protective effect (area C) illustrates the loss to Sudan resulting from wasted resources used to produce maize at a higher cost, and the consumption effect (area E) is the result of the decrease in consumption caused by the tariff artificially increasing the price of maize.

Complete the following table to summarize your results from the previous two graphs.

	Under Free Trade	Under a Tariff
	(Dollars)	(Dollars)
Consumer surplus	760,000	360,000
Producer surplus	40,000	1,600,000
Government revenue	0	720,000

Points:

0.2 / 1

Based on your analysis, as a result of the tariff, Sudan’s consumer surplusdecreases by

$13,000,000

, and producer surplusincreases by

$700,000

. Taking into account how much revenue the tariff generates for the government, the net welfare effect is aloss of

$200,000

Points:

0.5 / 1

By plugging in the values of each of the areas, you obtain the welfare effects of the tariff in the following dollar amounts:

Store	Free Trade	Tariff	Difference
Store	(Dollars)	(Dollars)	(Dollars)
Consumer surplus	4,860,000	3,840,000	–1,020,000
Producer surplus	60,000	240,000	+180,000
Government revenue	0	720,000	+720,000
Total surplus	4,920,000	4,800,000	–120,000

Consumer surplus decreases by $1.02 million, producer surplus increases by $180,000, and the government collects $720,000 in revenue because of the $40-per-ton tariff. Therefore, the net welfare effect is a loss of $120,000, which is equal to the area of the two deadweight loss triangles.

$Domestic Revenue Effect$	$=$	$Imports with Tariff \times (Domestic Price with Tariff - Free Trade Price)$
	$=$	$4 million barrels \times ($450 per barrel - $350 per barrel)$
	$=$	$$400 million$

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Homework (Ch 04)

1. Identifying types of tariffs

2. Calculating the effective rate of protection

3. Winners and losers from tariff reductions

4. Tariff effects: An overview

5. Effects of a tariff on international trade

6. Effects of a tariff in a small nation

7. Effects of a tariff in a large nation

8. The arguments for restricting trade

8. The arguments for restricting trade

8. The arguments for restricting trade

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