978-0078021770 Chapter 10 Solution Manual

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Suggested answer to case study discussion question

How Sweet It Is (or Isn’t): For a U.S. company that makes jelly beans in the United States, U.S.

policies that limit sugar imports increase sugar prices and raise the cost of obtaining the key

input into its production. The U.S. firm would like to change US. policy, to lower the domestic

price of sugar, for instance, by moving to or toward free trade in sugar. On its own, the firm

probably cannot have much impact politically, because anything it can do would be too small.

The firm could join the Coalition for Sugar Reform and contribute to the Coalition’s efforts to

oppose protectionist U.S. policies that limit sugar imports. However, this group’s efforts have

had little effect, because the sugar producers are better organized and willing to spend more

(campaign contributions and lobbying) to maintain the existing import-limiting policies. The

U.S. firm does have some other options. First, the firm could consider making jelly beans with

less sugar, but this probably would be risky for a gourmet brand. Second, the firm could consider

shifting its jelly bean production to another country which has freer trade in sugar (so that the

domestic sugar price is at or close to the low world price for sugar). The firm then would import

jelly beans for sale in the United States. (Jelly Belly actually moved production of jelly beans to

Thailand in 2007.)

Suggested answers to end of chapter questions and problems

1. a. Yes, there are external benefits—a positive spillover effect. The benefits to the entire

b. The economist would say that the production subsidy is preferable to the tariff. Both can

c. The economist would use the specificity rule. The actual problem is that innovating firms

do not have enough incentives to pursue new production technologies (because other

2. The specificity rule is a guide to government policy that tries to enhance economic

efficiency by addressing incentive distortions or market failures. It states that it is more

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3. One such set of conditions described in this chapter is the developing government

argument. If the government is so underdeveloped that the gains from starting or

4. The infant industry argument states that a country can benefit by shielding an industry

(the infant) that is currently uncompetitive against foreign rivals, if that industry can

lower its costs over time and become competitive in the future. It is potentially a valid

5. Yes, even though no such case was explicitly introduced in this chapter. Think about

distortions and ask how a nation could have too little private incentive to buy imports.

6. The national defense argument states that the government must limit imports during

peacetime to ensure that the country can meet its needs for defense goods during times of

war. While the need to provide for the national defense is clear, the specificity rule says to

7. Agree. The infant-industry argument states that a domestic industry that is currently

uncompetitive by world standards (uncompetitive against low-priced imports) will, if it can

begin producing with assistance from the government, grow up to become internationally

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8. a. i. The tariff would raise the domestic price from the world price P0 to the tariff-inclusive

ii. By increasing domestic production from S0 to S1, the country gains external benefits

P r i c e

( $ p e r

c l o c k )

M E B

( $ p e r

c l o c k )

acd

Q u a n t i t y ( c l o c k s )

gM E B

Q u a n t i t y ( c l o c k s )

iv. With a production subsidy instead of a tariff, the market price remains at P0. Domestic

consumption remains at D0. Producers receive revenue per unit produced equal to P1,

which includes both the market price and the government subsidy per unit produced.

v. The tariff creates revenue for the government equal to area c. The production subsidy

b. The specificity rule indicates that the best policy is to subsidize or support worker

9. Policy A, the production subsidy, would be the lowest cost to the country. By comparison,

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10. The interests of the sock exporting countries are probably to export a large quantity of

socks and to receive a high price for the socks that they export. Presume that the sock

importing countries are going to use one of these policies to achieve a specific target

quantity of domestic sock production. Consider first the effect on quantity of sock

11. In favor: Adjustment assistance is designed to gain the benefits of increased imports by

encouraging workers to make a smooth transition out of domestic production of the

import-competing good. A key problem is that workers pushed out of import-competing

production suffer large declines in earnings when forced to switch to some other industry

or occupation. Adjustment assistance can overcome this problem by offering workers

retraining, help with relocation, and temporary income support during retraining and

relocation. Adjustment assistance represents an application of the specificity rule. It is

better than using a tariff or nontariff barrier to limit imports and resist shrinking the

domestic industry. And politically, it can reduce the pressure to enact these import

barriers.

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12. The free-rider problem is the incentive that each individual has to contribute little or

nothing to a common endeavor, hoping that others will contribute and the individual will

13. Imposing the quota will create one clear winner—domestic baseball bat producers. It will

create one clear loser—domestic consumers of baseball bats. And it will create one group

that may have mixed feelings—the three import distributors—because they will have a

smaller volume of business, but the profit margin on the limited business that they conduct

14. Tariff escalation is that the size of the tariff rate tends to increase with the stage of

processing. The tariff rates on final consumer goods are usually higher than the tariff

rates on intermediate products and raw materials used to make the final products.

Because household consumers are a weak lobbying group, producers of final goods are

15. None. The loss in consumer surplus from imposing a tariff is larger than the gain in

16. The government has committed to the objective of reducing imports by one third. The

specificity rule offers guidance for the choice of government policy to achieve this

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C E K F

$ per shirt

PW + sub

PW + tar

shirts

Q1 Q2 Q5 Q3 Q4

To reduce imports by one third, the government would impose a tariff equal to tar per

unit. The domestic price rises to (PW + tar), domestic consumption decreases to Q3, and

domestic production increases to Q2. The quantity imported with the tariff (Q3 – Q2) is

equal to two thirds of the free trade (Q4 – Q1).The tariff causes two area of inefficiency,

area AEC (production inefficiency) and area BGF (consumption inefficiency).

What happens if, instead, the country’s government would use a production subsidy?

Consumers can still buy imports at PW, so they continue to buy Q4. To reduce imports by

one third, with domestic consumption at Q4, domestic production must increase more

(than with a tariff), to Q5 (rather than to Q2 with the tariff), so that imports (Q4 – Q5) are

equal to two thirds of (Q4 – Q1). Therefore, the production subsidy per unit (sub) must be

larger than the tariff rate (tar). The production subsidy causes inefficiency of area JKC

(production inefficiency).

Which policy causes a larger inefficiency? For the two triangles AEC and BGF, the

combined base is the reduction in imports, and the height is the tariff rate (tar). For the

one triangle JKC, the base is the same reduction in imports, and the height is the subsidy

rate (sub). Because the triangle JKC has a larger height, it is larger than the combination

of the two triangles AEC and BGF. The inefficiency of the tariff is smaller than the

inefficiency of the production subsidy. To achieve the import-reduction goal, the

economic cost to the country is smaller if the country uses a tariff.

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