Problem Set 4: Key

Suppose the U.S. is a small country in the global heavyweight motorcycle market. Consider the following about the approximate impact of U.S. tariffs imposed in the 1980s in the heavyweight motorcycle market (quantities are in 1000s):

	Free trade	$600 tariff
U.S. price	$3,400	$4,000
Quantity consumed (Qd)	200	150
Quantity produced (Qs)	100	125

Contrast the free trade and tariff situation in a domestic-market supply and demand diagram.
See diagram to right

Use information from the diagram to compute the value of the following effects of the tariff, and indicate where each one shows up in your diagram: (1) Change in consumer surplus, (2) Change in producer surplus, (3) Tariff revenue, and (4) Welfare cost of the tariff.
    DCS=-abcd=-105M; DPS=+a=+67.5M;
    DTR=+c=+15M; DNW=-bd=-22.5M
    (a=67.5M, b=7.5M, c=15M, d=15M)
    Answer key checklist: Did you calculate the actual numerical values for these effects?
    Did you use the right units? (millions of dollars)

An economic study estimated that the tariff created 700 jobs in the domestic motorcycle industry. How much did each of these jobs "cost" U.S. consumers? How much did each one cost the economy?
cost to consumers: $150,000; cost to economy: $32,143
Answer key checklist: Did you use the right units? (thousands of dollars)

Suppose that the government had instituted a quota policy instead. What is the quantity of import licenses that the government would issue to achieve the same price and quantity effects as the tariff?
25,000: the gap between Qd and Qs with the tariff

2.	a.	Use a domestic-market supply and demand diagram to illustrate an initial free trade equilibrium for a small country importer of beef. See diagram to the right
	b.	Use your diagram to depict an equivalent tariff and quota on beef. Tariff at Pf+tar = quota at S+QR.
	c.	Now suppose the demand for beef increases. Depict the consequences in your diagram. Show that, after the increase in demand, the country's welfare loss from protection is larger with the quota than with the tariff. Welfare loss from tariff: ab. Welfare loss with quota: abcdef. The quota loss is larger by areas cedf

3.	Consider China as a small-country importer. From 1992 to 1997, China reduced its (weighted average) tariff rate on imports from 40.9 percent to 28.9 percent. Illustrate the change in China's national welfare from its tariff reduction in a domestic market diagram for a typical item that China imports. See diagram to the right. DCS = gain = abcd DPS = loss = a DGRev = ? = -c+eg DNW = gain = +bedg dg=benefits in excess of world price on the consumption increase. be=costs in excess of world price on the production decrease.

4.	These questions are based on the course reading, "Japan's change in rice policy could hurt state's exports", (Los Angeles Times, December 18, 1998).
	a.	Illustrate Japan's situation in a Japanese domestic-market supply and demand diagram for rice. Use values from Passage B and Passage C of the article to label (1) the world price of rice, (2) the tariff, (3) the price of rice in Japan including the tariff, (4) consumption, (5) production, and (6) imports. For several of these values, provide approximate estimates based on information reported in the article. See diagram to right (1) Pw=$0.13; (2) tariff=$1.34; (3) Pj=$1.47; (4) Qd=10 mill. tons (5) Qs=9.3; (6) Qm=0.7
	b.	Consider Passage A from the article. Do you agree? If so, explain why. If not, then what alternatives are there? There are many options to "protect rice farmers": tariffs, quotas, VERs and subsidies, for example, are all possible.
	c.	Consider Passage D from the article. Are government trade restrictions necessary for the reasons given by Ms. Hanzaki? Why or why not? No prtection is necessary if the situation is that "Foreign rice tastes bad and Japanese rice is the best." If that's the case, consumers will choose Japanese rice even without a tariff. (With respect to the added claim that, "As long as Japan has a rice surplus, there's no need to import any," involves circular reasoning: the "surplus" is likely the result of the government support; without the support, lower prices would boost consumption, reduce domestic production, and boost the demand for imports.)

5.	Export subsidies: Use a trade-market supply and demand analysis to illustrate the consequences of an export subsidy implemented by a large-country exporter. Be sure to indicate the resulting prices buyers pay in the exporting country and in the importing country. Price importers pay = Pm' Price buyers pay in exporting country = Px' Dnational welfare: Importers: +ABC Exporter: Suppliers: +EF Taxpayers: -ABCDEF Total: -ABCD World: -D

6.	The following question draws on information from an article published in the March 10, 2007, edition of the Los Angeles Times, "Ethanol still a long way off in U.S." Assume that the U.S. is a small-country importer of ethanol. You may use diagrams to help you explain your answers, but diagrams are not required. You can receive full credit with careful explanations.
	a.	According to the article, "Bush wants Americans to produce and use ethanol, a fuel made from the alcohols refined from plant material." What policy option(s) would you recommend as best suited to promote the goals that Bush hopes to achieve? Explain the reasoning behind your recommendation(s). To increase production: a production subsidy. This directly promotes production by raising the price producers get to Pf + Psub To increase use: a consumption subsidy. This directly promotes consumption by lowering the price consumers pay to Pf - Csub.
	b.	Which goal do you think is more worthwhile from a global perspective, more U.S. production or or more U.S. consumption of ethanol? Why? More US consumption. Extra consumption of ethanol instead of fossil fuels will lower environmental damage.
	c.	For each of the following policies described in the article, indicate whether you think the policy promotes what Bush wants Americans to do, and support your answer with a domestic market supply and demand diagram for ethanol.
			(1)	"The U.S. ... grants ... a subsidy of 51 cents a gallon to companies that make ... ethanol." Promotes production: yes Promotes use: no; consumption is unchanged
			(2)	"[T]he U.S. government imposes a 54-cent-a-gallon tariff on ethanol imported from Brazil." Promotes production: yes Promotes use: no; consumption falls

7.	The U.S. is a small-country importer of firearms. Suppose that you are a member of the U.S. International Trade Commission and that you must recommend a policy for the firearms industry. Consider separately each alternative goal below, recommend a "first-best" policy (from the perspective of national welfare) and briefly explain your recommendation (diagrams are optional):
	a.	For national security purposes, it is deemed desirable to increase domestic firearms production by, say, 20 percent (the amount in each case is just suggestive--don't worry about it). Production subsidy: goal is to raise production; a production subsidy is most direct.
	b.	For national security purposes, it is deemed desirable to reduce dependency on imported firearms by 20 percent. Trade restriction: a tariff, or even better, a quota, is best here, since a specific physical limit on imports is the target.
	c.	For public safety purposes, it is deemed desirable to decrease domestic firearms consumption by 20 percent. Consumption tax: goal is reduce consumption; a consumption tax is most direct.

12.	For years, the European Union (EU) has favored banana imports from its former colonies by using trade policy to block imports of bananas grown in Ecuador and Central America and distributed by U.S. fruit companies such as Chiquita Brands and Dole. The EU has defended its policy as a form of foreign aid to its former colonies.
	a.	Use a trade market diagram to illustrate an equilibrium in which the EU is a large-country importer of bananas, but imports only from its former colonies. See equilibrium a in diagram to the right.
	b.	In a number of trade dispute settlement hearings in the 1990s, the WTO sided with the U.S. and and its banana exporting allies in ruling that the EU's discriminatory barriers violate international trade agreements. In your diagram from part a, illustrate the consequences of free trade in bananas, with imports from Ecuador and Central America no longer restricted by the EU and therefore becoming an extra source of import supply See equilibrium b in the diagram.
	c.	Indicate in your diagram:
		(1) The total change in the EU's gains from trade. DEU's gains from trade = +ABC
		(2) The total change in the former colonies' gains from trade. Extra foreign aid = Dcolonies' gains from trade = A
		(3) The net change in the EU's gains from trade if the EU increases foreign aid to its former colonies by the amount you indicated in part (2) in order to offset their losses from the trade liberalization. Net DEU's gains from trade = +BC
	d.	In implementing the WTO ruling, could all the parties involved in the dispute end up at least as well off as they were before the ruling? Explain briefly. The WTO ruling could make everyone at least as well off as before since former colonies end up at least as well off as before, EU ends up better off, and the newly added exporters gain as well.

8.	These questions concern the online course readings:
		Taylor (1999). Is free international trade harmful to the environment (1999) <http://faculty.oxy.edu/whitney/xaccess/ec311/iic_env_uw.htm> Smith (2000). Little by little, breathing easier in Mexico City <http://faculty.oxy.edu/whitney/xaccess/ec311/iic_envt_lat_2000.htm>
	a.	Would you expect Taylor to be surprised by the change in environmental quality in Mexico City in recent years? Why or why not? Taylor would not be surprised. He claims environmental quality is a normal good, so people want more of it as their income rises. Higher income also gives countries more resources to use for environmental purposes. So as Mexico gets wealthier, higher environmental quality should become a higher priority.
	b.	How would Taylor likely link (1) Nafta, (2) economic growth in Mexico, and (3) environmental quality in Mexico? Nafta should promote growth, which raises income, which raises demand for a cleaner environment.

10.	Use a trade-market supply and demand diagram to illustrate the consequences of an import tariff implemented by a large-country importer.
	a.	In your diagram, indicate the impact of the import tariff on:
		(1)	the exporter's gains from trade; Falls by de
		(2)	the importer's gains from trade before taking into account the impact on government revenue; falls by bc and
		(3)	government revenue of the importing country. rises by bd
	b.	Decide whether each of the following rises, falls, remains the same, or changes in an uncertain direction when a large country imposes a tariff, and be sure it is clear how you decided:
		(1)	national welfare of the exporting country; falls by de
		(2)	national welfare of the importing country; and falls by c; rises by d; net is uncertain
		(3)	global welfare. falls by ce

11.	EXERCISING MARKET POWER IN TRADE. Consider two large-country trading partners, OPEC, which exports oil, and the rest of the world, ROW, which imports oil.
	a.	Use a trade-market supply and demand diagram (with Dm by ROW and Sx by OPEC) to depict a free-trade equilibrium in the world oil market. See trade-market diagram to the right.
	b.	Now suppose that OPEC restricts its oil exports to ROW by imposing an export quota. Use your diagram to depict the consequences of OPEC's export quota. (hint: the export quota makes Sx by OPEC vertical at the quota amount.) An export quota=Q' => Sx vertical at Q'
	c.	Indicate in your diagram the changes in welfare for: (1) ROW, (2) OPEC, and (3) the world as a whole, which result from OPEC's export quota. (1) ROW importers lose bc (2) OPEC exporters gain b, lose e (3) World loses ce

9.	Suppose the diagram to the right shows the market for refined gasoline. The production of refined gasoline causes local air pollution which accounts for the gap between PMC and SMC illustrated in the diagram.
	a.	Suppose the country does efficiently enforce environmental quality regulations. Indicate its free-trade quantities produced, consumed and imported. See Qsf and Qdf in diagram to right. The distance between them = Qmf
	b.	Some have argued that free trade encourages countries to relax their environmental standards. Suppose this country does eliminate its environmental regulations. Indicate the impact on the country's quantities produced, consumed and imported. Qs rises from Qsf to Qs' Qd remains at Qdf Qm falls from Qsf-Qdf to Qs'-Qdf
	c.	Indicate in the diagram any changes in (1) consumer surplus, (2) producer surplus, (3) environmental damages and (4) national welfare which result from eliminating its environmental regulations. (1) CS remains the same (2) PS rises by the area in blue, since private production costs fall (3) environmental damages rise by the area in red, since safeguards are no longer used (4) national welfares falls by the top red triangle
	d.	From a national welfare perspective, does the country gain by reducing its environmental regulations under free trade? Explain briefly. No. National welfare falls as the country loses more from the new environmental damage than producers gain from the increase in their PS.