Taxes and International Trade:
Examples and Exercises
Lecture 9 – academic year 2015/16
Introduction to Economics
Dimitri Paolini
Index of examples/exercises
• Lect. 9.1 (taxes and welfare)
• Lect. 9.2 (taxes, elasticity and welfare)
• Lect. 9.3 (taxes and welfare, computation)
• Curiosity: Barbie and the globalization
• Lect. 9.4 (international trade)
• Lect. 9.5 Numerical exercise
• Lect. 9.6 (international trade)
2
Lect. 9.1
a) “If the Government introduced a tax on
land, the rich landowners would transfer (at
least part of) the tax burden to their poor
tenants”. Comment.
b) “If the Government introduced a tax on
real estate, the rich landlords would transfer
(at least part of) the tax burden to their
poor tenants”. Comment.
3
Lect. 9.1
a) This statement is wrong. Since the curve of
supply is perfectly inelastic the landowners
cannot transfer the tax burden to their poor
tenants. The latter do not share in the tax
burden.
b) This statement is correct. The effeect of the tax
depends on the elasticity of demand and
supply. The cost of the tax will be shared by
landlords and tenants. The impact of the tax
will be stringer in the long period.
4
Lect. 9.2
Let’s consider the market for rubber.
a)How would the tax burden be shared if the
supply curve is elastic and the demand curve is
inelastic?
b)What if the reverse holds (i.e. supply is inelastic
and demand is elastic)?
5
Lect. 9.2
P
Consumer
surplus
Supply
PC
A
P*
PP
C
B
D
Demand
Producer
surplus
Q*
Q
6
Lect. 9.2
a) In this case the tax burden is paid mainly by
consumers; since the demand curve is inelastic
consumers can hardly change their
consumption level following an increase in
price. The consumer surplus reduces of the are
A + C.
7
Lect. 9.2
Supply
P
A
PC
P*
B
C
Consumer
surplus
D
PP
Demand
Producer
surplus
Q*
Q
8
Lect. 9.2
b) In this case the tax burden is paid mainly by
the producers; since the supply curve is
inelastic they cannot adjust their production
following a change in price. The producer
surplus diminishes of the area B + D.
9
Lect. 9.3
a) The two equations describe the market:
QS = 2P
QD = 300 – P
10
Lect. 9.3
a) Find equilibrium price and quantity
QS = QD
2P = 300 – P
 3P = 300

P = 100
QS = QD = 200
11
Lect. 9.3
Suppose that a tax T is introduced on consumption
a)Compute the price received by producers
b)Compute the price paid by consumers
c)Compute the new equilibrium quantity
d)Compute the fiscal revenue and net loss
12
Lect. 9.3 (a)
If a new tax T is introduced on consumption the
price received by the producers is:
QS = QD
2P = 300 – (P + T)
2P = 300 – P – T
3P = 300 – T
P = 100 – T/3
13
Lect. 9.3 (b)
The price paid by consumers is:
P + T = (100 – T/3) + T 
da cui P + T = 100 + T(– 1/3 +1) 
therefore
P + T = 100 + 2T/3
14
Lect. 9.3 (c)
The quantity sold is:
QS = 2·P = 2 ·(100 – T/3) = 200 – 2T/3
Comments: as we expected, as a
consequence of the tax, the size of the
market reduces and the tax burden is
shared in by producers and consumers (1/3
is paid by the producers and 2/3 is paid by
the consumers).
15
Lect. 9.3 (d)
Find the fiscal revenue as a function of T,
knowing that it is equal to T· Q:
Fiscal revenue = T · Q  T · (200 – 2T/3) 
200·T – 2T2/3
16
Lect. 9.3 (d)
T
T·Q
0
100
0
13.333,3
150
200
300
15.000
13.333,3
0
17
Lect. 9.3 (d)
Graphically:
Revenue
15.000
0
150
300
T
18
Lect. 9.3 (d)
Derive the net loss as a function of T and
draw the graph for T included between
0 and 300.
19
Lect. 9.3 (d)
Supply
Value of the
tax
A
100+2T/3
100
100-T/3
B
T C
D
E
F
Demand
200 - 2T/3
200
20
Lect. 9.3 (d)
The net loss is equal to the triangle C + E, whose
base is T and height equal to the variation in
quantity, i.e. 200 – (200 – 2T/3) = 2T/3.
Therefore, the net loss is equal to ½ ( T x 2T/3) =
T2/3.
For algebra addicted: the net loss for values of T
included between 0 and 300 increases
exponentially.
21
Lect. 9.3 (d)
Graphically:
Net loss
0
300
T
22
Lect. 9.3
Is T = 200 optimal?
No because, as shown by the graph, at that point
the fiscal revenue reduces compared to the
values of T included between 0 and150.
The best decision is to set T = 150 if the objective
of the government is to maximize the fiscal
revenue, or T = 0 if the objective is to minimize
inefficiencies.
23
Barbie and the globalization?
24
Barbie is an American product?
(1 / 3)
Producer: US toys company (Mattel). However,
there are no plants in US to produce this doll.
Material inputs (rubber for body and hairs) come
from Taiwan and Japan.
The plate to produce the dolls as well as some
colours come from the US.
25
Barbie is an American product?
(2 / 3)
Assembly and decoration of the dolls is realized in
the Philippines and Taiwan (more recently
Indonesia, Malaysia and China).
Also the cotton textile used to produce the doll’s
dresses comes from China.
Most of the Barbie are sent to the US from Hong
Kong.
26
Barbie is an American product?
(3 / 3)
The value of the doll in 1995 in Hong Kong was $2.
The selling price in US was nearly $10, out of which $1 was
profit for Mattel and the rest was used to cover
transportation costs, distribution, etc.
In 2001 the sales of Barbie worldwide were equal to 1,6
billion US dollars. No doubt that the largest part of this
profits remain in the US (to Mattel, distributors and so on).
The idea of the product is America (and indeed the plates
come from there), however can we really call it an
American product?
27
Lect. 9.4
The world price of wine is lower than the one one
could get in US in the absence of international trade.
Draw the graph of the US wine market with
international trade and show in a table the consumer
surplus, producer surplus and total surplus.
What are the effects of a destruction of harvest on the
world price? Show graphically and with a table what
happens in the US market.
28
Lect. 9.4
P
Consumer
surplus
Internal supply
A
P*
B
D
P
World price
C
Producer
surplus
Import
QSint
Internal demand
QDint
Q
29
Lect. 9.4
US wine market in presence of free trade:
Consumer surplus
A+B+D
Producer Surplus
C
TOTAL SURPLUS
A+B+C+D
30
Lect. 9.4
WORLD market: effects of a cold summer
P
S2 world
S1 world
P2
P1
Demand world
Q2
Q
1
Q
31
Lect. 9.4
P
Consumer
surplus
Internal supply
A
P2
B
P
D
C
Producer
surplus
World price 2
World price 1
Import
QSint
Internal demand
QDint
Q
32
Lect. 9.4
P
Consumer
surplus
Internal supply
A
P2
B
P
World price 2
D
BI
World price 1
C
Internal demand
Producer
surplus
QSint
QDint
Q
33
Lect. 9.4
Consumer surplus
A
Producer surplus
C+B
TOTAL SURPLUS
A+B+C
34
Lect. 9.4
Following the reduction in the world supply of
wine and the consequent increase in world price,
the total surplus is decreased. Indeed:
A + B +C < A+B+C+D
35
Lect. 9.4
BUT:
The producer surplus is increased.
HOWEVER:
This increment is not sufficient to compensate the
reduction in consumer surplus.
36
Lect. 9.5
In the country of Copperland – whose economy is
completely closed – the price of copper is 10
Eurocent (for 100 Kg.).
37
Lect. 9.5
Questions:
(a) If the world price of copper is 100 Eurocent (for 100
Kg.), show (even with the help of a graph) what
happens to equilibrium price and quantity when the
Government of Copperland decides to open the
economy to free trade.
(b) If the demand for copper is given by equation Q
= 500 - 2P, compute the surplus of Copperland’s
consumer before and after the opening of the
economy.
38
Lect. 9.5 (a)
Answer:
a)The price of copper in Copperland is lower than the
world price (10 Eurocent < 100 Eurocent); when the
government open the economy the internal price
increases until is equal to the world price. In fact no
producer has the incentive to accept a price lower
than the world price.
39
Lect. 9.5 (a)
Price of
copper
Internal supply
Export
World price
Price under
a closed
economy
Internal demand
0
Internal quantity
demanded
Quantity
supplied
Quantity
of copper
40
Lect. 9.5 (b)
Answer:
b1) The surplus of producers before the opening of the
economy (in the absence of free trade) was equal to the
area included between the internal price and the supply
curve, while consumer surplus was equal to the area
included between the demand curve and the internal
price.
b2) With the opening of the economy, the surplus of
producers increases, while the surplus of consumers
decreases. Total surplus increases.
41
Lect. 9.5 (b)
Calculations: if the demand curve is Q = 500 - 2P, then the
vertical intercept (Q = 0) is P= 250 Eurocent (2,5 Euro).
In fact
0 = 500 – 2·P  P = 500/2 = 250
42
Lect. 9.5 (b)
Therefore the height of the triangle that represents the
consumer surplus is
Before: 250 – 10 Eurocent = 240, that is the difference with
respect to the internal price
After: 250 – 100 Eurocent 150, that is the difference with
respect to the World price
43
Price of copper
(Eurocent)
Lect. 9.5 (b)
Supply
250
10
Demand
0
480
Quantity of copper
44
Lect. 9.5 (b)
Calculations: the consumer surplus has the following base:
Before: 480 = quantity demanded in a closed economy,
i.e., with P= 10 Eurocent, Q=480
After: 300 = quantity demanded in an open economy, i.e.,
with P= 100 Eurocent, Q=300
45
Lect. 9.5 (b)
Results:
Before: surplus is (480 x 240)/2 = 57.600
After: surplus is (300 x 150)/2 = 22.500
Therefore the consumer surplus has decreased.
46
Price of copper
(Eurocent)
250
Lect. 9.5 (b)
Export
Supply
World price
100
10
Demand
0
300 480
Quantity of copper
47
Lect. 9.6
French duty on Italian wine import:
According to French wine producers a duty on
Italian wine import would increase fiscal revenue
and increase employment.
48
Lect. 9.6
P
Internal supply
The
introduction
of the duty
increases P
P*
P with duty
P without duty
World price
Internal demand
Q S1
QD1
Q
49
Lect. 9.6
P
Consumer
surplus
increases
Fiscal
revenue
…Import
decreases
P*
A
B
P with duty
D
P without duty
Producer
surplus
increases
Internal supply
E
F
World price
G
Internal demand
Q S1
Q O2
QD2
QD1
Q
50
Dumping
Dumping is when a country exports or sells prodcuts
in a foreign country for less than either the price in the
domestic market , or the cost of making the product.
In price-to-price dumping, the exporter uses higher
home-prices to supplement the reduced revenue from
lower export prices. In price-cost dumping, the
exporter is subsidized by the local government with
duty drawbacks, cash incentives, etc.