Unit 5.
Problem sets
Trade policy instruments
International Trade & Globalization (363003)
Prof. Sébastien Fontenay
Universidad de Alcalá
Question 1
• Suppose that Home’s demand curve for wheat is:
D = 100 – 20P
• Its supply curve is:
S = 20 + 20P
a) In Excel, graph Home’s supply and demand curves.
(Hint: Use a price range of 0 to 3)
b) Derive and graph Home’s import demand schedule.
c) What would the price of wheat be in the absence of
trade?
Answer to Q1
a) In Excel, graph Home’s supply and demand curves.
Home
Price D S
3,5
0.5 90 30
0.75 85 35 3
1 80 40 2,5
1.25 75 45
2
1.5 70 50
1.75 65 55 1,5
2 60 60
1
2.25 55 65
2.5 50 70 0,5
2.75 45 75 0
3 40 80 0 20 40 60 80 100
S D
Answer to Q1
b) Derive and graph Home’s import demand schedule.
• The import demand equation, MD, is found by subtracting the
Home supply equation from the Home demand equation:
MD = 80 − 40 × P
Home Home's import demand
3,5 3,5
3 3
2,5 2,5
2 2
1,5 1,5
1 1
0,5 0,5
0 0
0 20 40 60 80 100 0 20 40 60 80
S D MD
Answer to Q1
c) What would the price of wheat be in the absence of
trade?
• Without trade, domestic prices and quantities adjust
such that import demand is 0. Thus, the price in the
absence of trade is 2.
Question 2
• Now add Foreign, which has a demand curve:
D* = 80 – 20P
• Its supply curve is:
S* = 40 + 20P
a) Derive and graph Foreign’s export supply curve and find
the price of wheat that would prevail in Foreign in the
absence of trade.
b) Now allow Foreign and Home to trade with each other,
at zero transportation cost. Derive and graph the
equilibrium under free trade. What is the world price?
What is the volume of trade?
Answer to Q2
a) Derive and graph Foreign’s export supply curve; find the
price that would prevail in the absence of trade.
Foreign’s export supply curve is XS = −40 + 40 × P.
In the absence of trade, the price is 1.
Foreign Foreign's export supply
3,5 3,5
3 3
2,5 2,5
2 2
1,5 1,5
1 1
0,5 0,5
0 0
0 50 100 150 0 20 40 60 80 100
S D XS
Answer to Q2
b) Now allow Foreign and Home to trade with each other,
at zero transportation cost.
When trade occurs, export supply is equal to import
demand:
XS = MD
−40 + 40 × P = 80 − 40 × P
80 × P = 120
P=1.5
Volume of trade is: MD = 80 − 40 × 1.5 = 20
Answer to Q2
b) Now allow Foreign and Home to trade with each other,
at zero transportation cost.
World market
3,5
2,5
1,5
0,5
0
0 10 20 30 40 50 60 70
XS MD
Question 3
• Home imposes a specific tariff of 0.5 on wheat imports.
a) Determine and graph the effects of the tariff on:
(i) the world price of wheat; (ii) the volume of trade.
b) Determine the effect of the tariff on:
(i) the price in Home; (ii) quantities supplied and demanded.
c) Show graphically the effects on the welfare of:
(i) Home import-competing producers; (ii) Home consumers;
(iii) Home government.
d) Calculate for Home:
(i) the terms of trade gain; (ii) the efficiency loss, and (iii) the
total effect on welfare.
Answer to Q3
• Home imposes a specific tariff of 0.5 on wheat imports.
a) Effects of the tariff on world price and trade.
The new MD curve is 80 − 40 × (P + t) where t is the specific tariff rate. The
equation for the export supply curve by the foreign country is unchanged.
MD = XS
80 − 40 × (P + 0.5) = 40P − 40
80 − 20 − 40P = 40P − 40
80P = 100
PWorld = 1.25
Trade = MD = XS = (40 × 1.25) − 40 = 10
Answer to Q3
• Home imposes a specific tariff of 0.5 on wheat imports.
a) Effects of the tariff on world price and trade.
World market
3,5
2,5
1,5
0,5
0
0 5 10 15 20 25 30 35 40 45
XS MD
Answer to Q3
• Home imposes a specific tariff of 0.5 on wheat imports.
b) Effects of the tariff on price and quantities at Home.
PHome = PWorld + t = 1.25 + 0.5 = 1.75
DHome = 100 − (20 × 1.75) = 65
SHome = 20 + (20 × 1.75) = 55
Answer to Q3
• Home imposes a specific tariff of 0.5 on wheat imports.
c) Show graphically the welfare implications for Home.
→ Consumer loss: -(a + b + c + d)
→ Producer gain: a
65 → Government revenue: c + e
Answer to Q3
• Home imposes a specific tariff of 0.5 on wheat imports.
d) Calculate ToT gain, efficiency loss, and total effect on
welfare.
The areas in the figure are:
(a) → 55(1.75 − 1.50) −0.5(55 − 50)(1.75 − 1.50) = 13.125
(b) → 0.5(55 − 50)(1.75 − 1.50) = 0.625
(c) → (65 − 55)(1.75 − 1.50) = 2.50
(d) → 0.5(70 − 65)(1.75 − 1.50) = 0.625
(e) → (65 − 55)(1.50 − 1.25) = 2.50
(Note: In the calculations for the a, b, and d areas, a figure of 0.5 shows up. This is
because we are measuring the area of a triangle, which is one-half of the area of the
rectangle defined by the product of the horizontal and vertical sides.)
Answer to Q3
• Home imposes a specific tariff of 0.5 on wheat imports.
d) Calculate ToT gain, efficiency loss, and total effect on
welfare.
▪ Consumer surplus change: -(a + b + c + d) = −16.875
▪ Producer surplus change: a = 13.125
▪ Government revenue change: c + e = 5
→ Efficiency losses b + d are exceeded by terms of
trade gain e.
Question 4
• Suppose that Foreign had been a much larger country,
with domestic demand:
D* = 800 – 200P
S* = 400 + 200P
a) Recalculate the free trade equilibrium and the effects of
a 0.5 specific tariff by Home.
b) Relate the difference in results to the discussion of the
small country case from the theoretical lecture.
Answer to Q4
a) Recalculate the free trade equilibrium and the effects of
a 0.5 specific tariff by Home.
Using the same solution methodology as in Question 3,
when the Home country is very small relative to the Foreign
country, its effects on the terms of trade are expected to be
much smaller. The small country is much more likely to be
hurt by its imposition of a tariff.
→ The free trade equilibrium is now at the price $1.09
and the trade volume is now 36.40.
Answer to Q4
a) Recalculate the free trade equilibrium and the effects of
a 0.5 specific tariff by Home.
With the imposition of a tariff of 0.5 by Home, the new world price
is $1.045, the internal Home price is $1.545, Home demand is
69.10 units, Home supply is 50.90, and the volume of trade is
18.20.
When Home is relatively small, the effect of a tariff on world
price is smaller than when Home is relatively large. When
Foreign and Home were closer in size, a tariff of 0.5 by Home
lowered world price by 25%, whereas in this case the same tariff
lowers world price by about 5%.
Answer to Q4
b) Relate the difference in results to the discussion of the
small country case from the theoretical lecture.
The internal Home price is now closer to the free trade price plus t
than when Home was relatively large. In this case, the
government revenues from the tariff equal 9.10, the consumer
surplus loss is 33.51, and the producer surplus gain is 21.089.
The distortionary losses associated with the tariff (areas b + d)
sum to 4.14 and the terms of trade gain (e) is 0.819. Clearly, in
this small country example, the distortionary losses from the tariff
swamp the terms of trade gains.
The general lesson is that the smaller the economy, the larger
the losses from a tariff because the terms of trade gains are
smaller.
Question 5
• What would be the effective rate of protection on
bicycles in China if China places a 50 percent tariff on
bicycles, which have a world price of $200, and no tariff
on bike components, which together have a world price
of $100?
Answer to Q5
• What would be the effective rate of protection?
The effective rate of protection (ERP) is defined as:
(Vt − Vw)/Vw
where Vt is the Value Added (VA) under protection and Vw is
the VA under free trade. VA is the difference b/w price of the
final good and price of components.
Vw = $200 − $100 = $100
With a 50% tariff on bicycles (and a 0% tariff on components),
Vt = ($200 × 1.5) − $100 = $300 − $100 = $200. Therefore, the
ERP = (200 − 100)/100 = 100%.
Wooclap
• Go to [Link] and use the code UAHTRADEU5