EC336 International Trade
Spring Term 2026
Problem Set 5
(1)
A small country can import a good at a world price of 10 per unit. The domestic
supply curve of the good is:
𝑆 = 50 + 5𝑃
The demand curve is:
𝐷 = 400 − 10𝑃
In addition, each unit of production yields a marginal social benefit of 10.
(a) Calculate the total effect on welfare of a tariff of 5 per unit levied on imports.
(b) Calculate the total effect of a production subsidy of 5 per unit.
(c) Why does the production subsidy produce a greater gain in welfare than the
tariff?
(d) What would the optimal production subsidy be?
(2)
Suppose that demand and supply are exactly as described above but there is no
marginal social benefit to production. However, for political reasons the government
counts a pound s worth of gain to producers as being worth £2 of either consumer
gain or government revenue. Calculate the effects on the government’s objective
(i.e. on consumer surplus plus its own revenue plus twice the producer surplus) of
a tariff of 5 per unit.
(3)
Suppose that in the wake of the European Union’s Eastern enlargement in 2004,
it has been discovered that the cost of automobile production in Poland is €14,000
while it is €20,000 in Germany. Suppose that the EU, which has a customs union,
has an X percent tariff on automobiles and that the costs of production are equal
to Y (valued in €) in Japan. Comment on whether the addition of Poland to the
EU would result in trade creation or trade diversion under the following scenarios:
(a) X =50% and Y = €10;000
(b) X =100% and Y = €10;000
(c) X = 100% and Y = €8;000
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(4)
Former French President Jacques Chirac announced a project to create a European
search engine called Quaero that would provide competition for Google and other
search engines. Suppose that the European Commission asked you to develop a brief
on behalf of subsidising such software developments - bearing in mind that the
software industry is currently dominated by U.S. firms, notably Microsoft and Google.
What arguments would you use? What are the weaknesses of those arguments?
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