Import Tariffs and Quotas
Under Perfect Competition
1. The following questions refer to Side Bar: Key Provisions of the GATT.
a. If the United States applies a tariff to a particular product (e.g., steel) imported
from one country, what is the implication for its steel tariffs applied to all other
countries according to the “most-favored-nation” principle?
b. Is Article XXIV an exception to most favored nation treatment? Explain why or
c. Under the GATT articles, instead of a tariff, can a country impose a quota
(quantitative restriction) on the number of goods imported? What has been one
exception to this rule in practice?
S-59
7
S-60 Solutions n Chapter 7 Import Tariffs and Quotas Under Perfect Competition
2. Consider a small country applying a tariff t to imports of a good like that represented
in Figure 7-9.
a. Suppose that the country decides to reduce its tariff to t 9. Redraw the graphs
for the Home and import markets and illustrate this change. What happens to
the quantity of goods produced at Home and their price? What happens to the
quantity of imports?
b. Are there gains or losses to domestic consumer surplus due to the reduction in
tariff? Are there gains or losses to domestic producer surplus due to the reduction
in tariff? How is government revenue affected by the policy change? Illustrate
these on your graphs.
Answer:
Quantity
S1S3S2D2D3D1M2M3M1
(a) Domestic market (b) Import market
Imports
Price Price
Solutions n Chapter 7 Import Tariffs and Quotas Under Perfect Competition S-61
c. What is the overall gain or loss in welfare due to the policy change?
3. Consider a large country applying a tariff t to imports of a good like that represented
in Figure 7-9.
a. How does the export supply curve in panel (b) compare with that in the small-
country case? Explain why these are different.
b. Explain how the tariff affects the price paid by consumers in the importing coun-
try, and the price received by producers in the exporting country. Use graphs to
illustrate how the prices are affected if (i) the export supply curve is very elastic
(flat) or (ii) the export supply curve is inelastic (steep).
Answer:
Refer to Figure 7-5: In the small-country case (flat export supply curve), a
Quantity
Price Price
X*
(a) Home Market (b) Import Market
PWc
D
bcd
M
S1D2
S2D1Imports
M1
M2
S-62 Solutions n Chapter 7 Import Tariffs and Quotas Under Perfect Competition
4. Consider a large country applying a tariff t to imports of a good like that represented
in Figure 7-9. How does the size of the terms-of-trade gain compare with the size
of the deadweight loss when (i) the tariff is very small, and (ii) the tariff is very large?
Use graphs to illustrate your answer.
5. a. If the foreign export supply is perfectly elastic, what is the optimal tariff Home
should apply to increase welfare? Explain.
b. If the foreign export supply is less than perfectly elastic, what is the formula for
the optimal tariff Home should apply to increase welfare?
t 5
E
X
*
, where E X
c. What happens to Home welfare if it applies a tariff higher than the optimal
tariff?
6. Rank the following in ascending order of Home welfare and justify your answers. If
two items are equivalent, indicate this accordingly.
a. Tariff of t in a small country corresponding to the quantity of imports M
b. Tariff of t in a large country corresponding to the same quantity of imports M
c. Tariff of t 9 in a large country corresponding to the quantity of imports M 9 . M
Answer: For the same quantity of imports, M, Home welfare is greater in the
large-country case relative to the small-country case because (assuming an opti-
mal tariff) the terms-of-trade gain partially offsets the deadweight losses due to
the tariff; thus, a < b for sure.
7. Rank the following in ascending order of Home welfare and justify your answers. If
two items are equivalent, indicate this accordingly.
a. Tariff of t in a small country corresponding to the quantity of imports M
b. Quota with the same imports M in a small country, with quota licenses distrib-
uted to Home firms and no rent seeking
c. Quota of M in a small country with quota licenses auctioned to Home firms
d. Quota of M in a small country with the quota given to the exporting firms
Case 1
S-64 Solutions n Chapter 7 Import Tariffs and Quotas Under Perfect Competition
e. Quota of M in a small country with quota licenses distributed to rent-seeking
Home firms
8. Why did President George W. Bush suspend the U.S. tariffs on steel seventeen
months ahead of schedule?
9. What provision of U.S. trade law was used by President Barack Obama to apply a
tariff on tires imported from China? Does this provision make it easier or harder to
apply a tariff than Section 201?
10. No U.S. tire producers joined in the request for the tariff on tires in 2009. Rather,
the petition for a tariff on tires imported from China was brought by the United
Steelworkers of America, the union who represents workers in the tire industry.
Why did major tire manufacturers operating in the United States, like Goodyear,
Michelin, Cooper, and Bridgestone, not support the tariff?
11. Suppose Home is a small country. Use the graphs below to answer the questions.
a. Calculate Home consumer surplus and producer surplus in the absence of trade.
Quantity
S
DM
2624
4
6
8
9
14
56 8
X*
X*+ t
(a) Home market (b) Import market
Import
Price Price
Solutions n Chapter 7 Import Tariffs and Quotas Under Perfect Competition S-65
Answer:
b. Now suppose that Home engages in trade and faces the world price, P
Determine the consumer and producer surplus under free trade. Does Home
benefit from trade? Explain.
c. Concerned about the welfare of the local producers, the Home government
imposes a tariff in the amount of $2 (i.e., t 5 $2). Determine the net effect of
the tariff on the Home economy.
12. Refer to the graphs in Problem 11. Suppose that instead of a tariff, Home applies an
import quota limiting the amount foreign can sell to 2 units.
a. Determine the net effect of import quota on the Home economy if the quota
licenses are allocated to local producers.
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b. Calculate the net effect of the import quota on Home’s welfare if the quota rents
are earned by foreign exporters.
13. Consider a small country applying a tariff t such as in Figure 7-5. Instead of a tariff on
all units imported, however, we will suppose that the tariff applies only to imports in
excess of some quota amount M 9 (which is less than the total imports). This is called
a “tariff-rate quota” (TRQ) and is commonly used on agricultural goods.
a. Redraw Figure 7-5, introducing the quota amount M 9. Remember that the
tariff applies only to imports in excess of this amount. With this in mind, what
is the rectangle of tariff revenue collected? What is the rectangle of quota rents?
Explain briefly what quota rents mean in this scenario.
Answer: Refer to the following figure: For the small-country tariff case, tariff
b. How does the use of a TRQ rather than a tariff at the same rate affect Home
welfare? How does the TRQ, as compared with a tariff at the same rate, affect
Foreign welfare? Does it depend on who gets the quota rents?
PricePrice
Quantity Import6
S
X
2
86542
4
8
9
14
(a) Home market (b) Import market
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c. Based on your answer to (b), why do you think TRQs are used quite
often?
14. Consider the following hypothetical information pertaining to a country’s imports,
consumption, and production of T-shirts following the removal of the MFA quota:
a. Graph the effects of the quota removal on domestic consumption and
production.
b. Determine the gain in consumer surplus from the removal of the quota.
Quantity
S
D
M
ba
S1S2D2D1M2
MM1
X* + t
P*
+ t
(a) Domestic market (b) Import market
Imports
Price Price
Without MFA
With MFA (Free Trade)
World price ($/shirt) $2.00 $2.00
Domestic price ($/shirt) $2.50 $2.00
Domestic consumption (million shirts/year) 100 125
Domestic production (million shirts/year) 75 50
Imports (million shirts/year) 25 75
S-68 Solutions n Chapter 7 Import Tariffs and Quotas Under Perfect Competition
c. Determine the loss in producer surplus from the removal of the quota.
d. Calculate the quota rents that were earned under the quota.
e. Determine how much the country has gained from removal of the quota.
15. Suppose that a producer in China is constrained by the MFA to sell a certain num-
ber of shirts, regardless of the type of shirt. For a T-shirt selling for $2.00 under free
trade, the MFA quota leads to an increase in price to $2.50. For a dress shirt selling
for $10.00, the MFA will also lead to an increase in price.
a. Suppose that the MFA leads to an increase in the price of dress shirts from $10
to $11. Will the producer be willing to export both T-shirts and dress shirts?
(Remember that only a fixed number of shirts can be exported, but of any type.)
Explain why or why not.
Without MFA
With MFA (Free Trade)
Domestic price of t-shirt ($/shirt) $2.50 $2.00
Domestic price of dress shirt ($/shirt) $? $10.00
Price
Quantity
S
X
25 751251007550
(a) Home market (b) Import market
Import
Price
Solutions n Chapter 7 Import Tariffs and Quotas Under Perfect Competition S-69
b. For the producer to be willing to sell both T-shirts and dress shirts, what must be
the price of dress shirts under the MFA?
c. Based on your answer to part (b), calculate the price of dress shirts relative to
T-shirts before and after the MFA. What has happened to the relative price due
to the MFA?
d. Based on your answer to part (c), what will happen to the relative demand in
the United States for dress shirts versus T-shirts from this producer due to the
e. Thinking now of the total export bundle of this producer, does the MFA lead
to quality upgrading or downgrading? How about the removal of the MFA?