PROBLEM SET 6
PUGEL 14, p. 195-196: #1*, 2, 3*, 5*, 7*
*Answers in back of book
1.
The diagram below depicts an import quota of 100,000 cell phones imposed by a
small country. The quota raises the domestic price from the free trade level of $100 to a
level of $150.
Price ($ per cell phone)
Sd
Sd + Quota
$150
Quota=100
$100
150
200
300
350
Cell phones (thousands)
Using the information in the diagram, mark each of the following in the diagram and
calculate their dollar-value:
a.
The revenue gained by the government by auctioning licenses at $50 each.
b.
The tariff-equivalent revenue of the quota.
c.
The value of the increase in producer surplus associated with the imposition of
the quota.
d.
The value in the decrease in consumer surplus associated with the imposition of
the quota.
e.
The net effect on the country’s imposition of the quota.
2.
Bakers in the kingdom of Leinster have petitioned their government officials for
protection from competition from imported bread from the kingdom of Saxony. You
have been hired by the government to discuss the options available. The minister of
trade wants to know about the ease of implementation and the welfare effects of the
following:
a.
An import quota of 40 million loaves.
b.
A VER of 40 million loaves.
2
3.
Suppose that the U.S. government is under heavy pressure from the Rollerblade
and K2 companies to put the brakes on imports of Bauer in-line skates from Canada.
The protectionists demand that the price of a $200 pair of in-line skates must be raised
to $250 if their incomes are to be safe. The U.S. government has three choices:
(1) Free trade with no protection.
(2) A special tariff on in-line skates.
(3) Forcing Bauer of Canada to agree to a voluntary export restraint.
The three choices would lead to these prices and annual quantities.
With Free Trade
$200
$200
With a $50 tariff
$250
$200
With a VER
$250
$200
Domestic U.S. price per pair
World price per pair
Imports of in-line skates
(millions of pairs)
10
6
6
**Note that the $50 tariff reduces imports by 4 million pairs a year, the same restriction that the
VER arrangement would enforce.
These choices are also illustrated by the diagram below:
Price of imported (and U.S.) skates (per pair)
Price with tariff or VER = $250
Free trade price = $200
Dm
0
6
10
U.S. imports = exports to
U.S. (millions of pairs
per year)
Calculate the net welfare effect of the tariff on the U.S. and the net welfare effect of the
VER on the U.S., relative to free trade. Which of the three choices looks best for the
United States as a whole? Which looks worse?
3
4.
For a small country, consider a quota and an equivalent tariff that permit the
same initial level of imports. This is illustrated below:
Price of imports
Price of imports
SX = Quota
PW + t
SM (tariff)
Pquota
PW
PW
Dm
Mt
Imports
With
Tariff
Small Country
Imports (M)
= Exports
to Small Country
Dm
MQ
Small Country
Imports (M)
= Exports
to Small Country
Imports
With
Quota
The market is competitive, and the government uses fixed favoritism to allocate quota
permits.
There is now an increase in domestic demand (and therefore the import demand
curve, Dm, shifts to the right). If the tariff rate is unchanged and the quota quantity is
unchanged, are the two still equivalent? Show this in the graph and explain.
4
Answers to questions in the textbook
NOTE: Answers to odd-numbered questions are in the back of the book
2.
Voluntary Export Restraint (VER) agreements are non-tariff barriers to trade.
Despite the name, the importing-country government coerces the exporting-country
government into allocating a limited quota of exports among its exporting firms. Before
VERs were outlawed by the WTO (in the Uruguay Round), importing-country
governments often forced exporters into accepting VERs because they wanted to limit
imports without explicit import barriers like tariffs or import quotas that would violate
international agreements or that would make them look “anti-free-trade.” In choosing
VERs, the importing-country government does not create a bigger national gain than
with tariffs or quotas. On the contrary, a VER allows foreign exporters to gain the full
price mark-up that the importing country could have kept for itself if it had used a tariff
or quota. (Gaining this price mark-up is a reason that the exporting country may agree
to a VER, rather than risking that the importing-country government will impose its
own import limits.)
Answers to Additional Problems
1.
a.
b.
c.
d.
e.
$50 x imports = $50 x 100 = $5000 (area C below)
The revenue from a tariff would be the same as the answer to part a.
$8750 (area A) = ($50 x 150) + (1/2 x $50 x 150)
$16,250 (areas A+B+C+D)
Assuming that the quotas are auctioned, the net welfare effect = gains –
losses = $8750 + $5000 - $16,250 = - $2500 (negative of areas B+D).
Price ($ per cell phone)
Sd
Sd + Quota
$150
Quota=100
A
B
C
D
$100
SROW
150
200
300
350
Cell phones (thousands)
5
2.
a.
A quota can be a very effective way of reducing imports; it strictly limits
quantities whereas tariffs do not. The quota licenses can be auctioned to the highest
bidders or can be passed out as political favors – buying votes or “good behavior.” The
Leinster government should be aware that a domestic bread monopoly may arise under
the protection of a quota, and this will be a welfare-reducing event.
b.
Leinster could try to force Saxony to accept a VER of 40 million loaves.
With a VER, the Leinster government gets no revenues, but it gets to appear as if it still
promotes free trade.
3.
Price of imported (and U.S.) skates (per pair)
Price with tariff or VER = $250
C
B+D
Free trade price = $200
DM
0
6
10
U.S. imports = exports to
U.S. (millions of pairs
per year)
Net welfare effect from tariff compared with Free Trade = areas –(B+D) =
- $100 million.
Net welfare effect from VER compared with Free Trade = areas – (B+C+D) =
- $400 million.
4.
They are no longer equivalent. The tariff does not limit the quantity of imports.
Thus, an increase in demand will allow consumers to import more at PW+t. The quota
restricts the quantity of imports each period to MQ. Thus, if the quota has been filled
and demand increases, consumers must buy additional units from domestic producers,
who given the increase in demand, will be able to charge a price higher than Pquota.