1. What is trade policy?
Explain the instruments of trade policy (tariff and non-tariff
barriers).
+ Trade policy is the regulations and arguments to control imports and exports between
countries.
+Trade policy can include the use of import tariffs (taxes on imports), import quotas (limits on
imports), and subsidies for exports.
- Instruments of trade policy
+ Tariff barriers: make imports products more expensive than domestic products and imposed
by a government.
+ Non-tariff barriers: the restricting of imports or exports to control the amount of trade
frequently with other countries
2. Present and graphically explain the following concepts: Consumer Surplus (CS),
Producer surplus (PS); Economic (Welfare) Surplus (ES).
+ Consumer Surplus is the difference between the price the consumers are willing to pay and
the actual equilibrium price in the market.
+ Producer surplus is the difference between the market equilibrium price and the prices
producers are willing to sell.
+ Economic Surplus can be measured by adding up consumer and producer surplus.
3. Using CS, PS, and ES to evaluate effect of tariff policy- the small country case.
Effect of tariff policy on Consumer surplus:
+ With the tariff, consumers now pay the higher price, PW+t, and their surplus is the area under
the demand curve and above the higher price, PW+t.
+The fall in consumer surplus due to the tariff is the area in-between the two prices and to the
left of Home demand, (a+b+c+d) in panel (a.1) of figure 8.5
+This area is the amount that consumers lose due to the higher price caused by the tariff
- Effect of tariff on Producer surplus:
+ With the tariff, producer surplus is the area above the supply and below the higher price,
PW+t.
+ Since the tariff increases Home price, firms can sell more goods, and producer surplus
increases
+This area, a in figure 8.5 (a.2), is the amount that Home firms gain due to the higher price
caused by the tariff.
+ Increases in producer surplus can benefit Home workers but at the expense of consumers.
- Effect of the Tariff on Government Revenue
+ In addition to the tariff’s impact on consumers and producers, it also affects government
revenue
+ The amount of revenue collected is the tariff t times the quantity of imports (D 2 – S2).
+ In figure 8.5 panel (a.3), the revenue is shown by area c.
+ The collection of revenue is a gain for the government in the importing country.
- Effect of tariff on Economic Surplus
Fall in consumer surplus: -(a+b+c+d)
Rise in producer surplus: +a
Rise in government revenue: +c
Net effect on Home welfare: -(b+d)
+ The areas b and d in figure 8.5 (a) correspond to the triangle (b+d) in figure 8.5 (b) and is the
net welfare loss.
We refer to this area as a deadweight loss—it is not offset by a gain elsewhere in the
economy.
4. Using CS, PS, and ES to evaluate effect of tariff policy – the large country case.
+ As for the large importing country, its tariff policy will affect the World price of the good.
- For example:
P*: The actual price that foreign exporters receive after paying a tariff of t$/per unit to
the importing country.
(P*+ t) = new selling price in the importing country
Pw: the world price of the good before tariff
+ Economic Welfare:
Fall in consumer surplus: -(a+b+c+d)
Rise in producer surplus: +a
Rise in government revenue: +(c+e)
Net effect on Home welfare: -(b+d) + e
+ The triangle (b+d) is the deadweight loss due to the tariff.
+ Area e offsets part of the loss.
+ If e > (b+d), then Home is better off.
+ If e < (b+d), then Home is worse off.
+ Home welfare may improve, but it comes at the expense of foreign exporters.
- Foreign and World Welfare
The Foreign loss, measured by (e+f), is the loss in Foreign producer surplus from selling
fewer goods to Home at a lower price.
The area e is the terms-of-trade gain for Home (P*<PW) but an equivalent terms-of-trade
loss for Foreign.
Additionally, there is an extra deadweight loss in Foreign of f, giving a combined total
greater than the benefits to Home.
World Welfare loss = b + d + f
B.
a) Pw= 450$
=> Domestic demand: (D): 450= -1/2*Q + 600 -> Qd= 300
=> Domestic supply: (S): 450= 1/2*Q + 350 -> Qs= 200
b) Domestic price= 450 + 10 = 460= Pw+t
Domestic demand: (D): 460= -1/2*Q + 600 -> Qd = 280
Domestic production: (S): 460= 1/2*Q + 350 ->Qs =220
c) Change in Consumer surplus: ΔCS= - a – b – c – d = - (Qd1+Qd2)*t/2 = - 2900
Change in Producer surplus: ΔPS = +a =[Qs1+Qs2]*t/2 =2100
Government Income from Tariff: ΔYg = M2*t =(Qd2-Qs2)*t =600
Change in Economic Surplus: ΔES = ΔCS + ΔPS + ΔYg = -200
=> Dead weight loss= -b-d= -200
d) Even though tariff cause Deadweight loss, many developing countries still using it because:
+ To protect domestic goods with cheaper price against foreign goods
+ Raise a steady revenue for government for investment in future
+ Protect domestic goods from “dumping” by foreign companies for governments which mean
that they charge a price in domestic market which under cost of the items value in domestic
market.
+ Protect aging and inefficient domestic industries from foreign companies.
e) When Vietnamese government increase its tariff on the imported rice from Thailand and
Japan, it will increase the price of rice (P) which increase Quantity supply (Qs) and reduce
Quantity demand (Qs).
