At the international price of $20/unit, domestic production is 5,000 units and domestic consumption is 6,000 units. With a 20 percent tariff, domestic production increases by 20 percent and domestic consumption decreases by 25 percent. What is the effect of this tariff on the affected parties? What is the net welfare effect on the country as a whole?

Question

Quizplus · Accepted Answer

The Answer is To analyze the effect of a 20 percent tariff on the affected parties and the net welfare effect on the country as a whole, we need to calculate the changes in domestic production and consumption, as well as the impact on consumers, producers, and the government revenue. Let's break it down step by step:

1. **Initial Situation without Tariff:**
- International price: $20/unit
- Domestic production: 5,000 units
- Domestic consumption: 6,000 units
- Imports: 6,000 units - 5,000 units = 1,000 units

2. **With a 20% Tariff:**
- Tariff: 20% of $20 = $4/unit
- New domestic price: $20 + $4 = $24/unit

3. **Changes in Domestic Production:**
- Increase by 20%: 20% of 5,000 units = 1,000 units
- New domestic production: 5,000 units + 1,000 units = 6,000 units

4. **Changes in Domestic Consumption:**
- Decrease by 25%: 25% of 6,000 units = 1,500 units
- New domestic consumption: 6,000 units - 1,500 units = 4,500 units

5. **New Imports with Tariff:**
- New imports: 4,500 units (consumption) - 6,000 units (production) = -1,500 units
- Since domestic production now meets domestic consumption, there are no imports.

6. **Effect on Consumers:**
- Consumers now pay a higher price for the goods ($24/unit instead of $20/unit).
- They also consume fewer goods (4,500 units instead of 6,000 units).
- Consumer loss: Higher prices and reduced consumption lead to a loss in consumer surplus.

7. **Effect on Producers:**
- Producers benefit from the tariff as it protects them from international competition.
- They are able to sell more units at a higher price (6,000 units at $24/unit instead of 5,000 units at $20/unit).
- Producer gain: Increased production and higher prices lead to an increase in producer surplus.

8. **Government Revenue:**
- With the tariff, the government would have collected revenue on the imports.
- However, since the tariff has eliminated imports, there is no tariff revenue.

9. **Net Welfare Effect:**
- The net welfare effect is the sum of the changes in consumer surplus, producer surplus, and government revenue.
- Consumer surplus decreases due to higher prices and reduced consumption.
- Producer surplus increases due to higher prices and increased sales.
- Government revenue does not change because imports have been eliminated.
- There may also be a deadweight loss due to the market being less efficient with the tariff. This is because resources may be allocated to domestic production that could be used more efficiently elsewhere, and consumers are paying higher prices for fewer goods.

To determine the exact net welfare effect, we would need to quantify the changes in consumer and producer surplus, as well as calculate the deadweight loss. However, generally speaking, tariffs tend to lead to a net welfare loss for the country as a whole because the losses to consumers typically outweigh the gains to producers and any government revenue, and the economy suffers from inefficiencies introduced by the tariff.

At the International Price of $20/unit, Domestic Production Is 5,000