Should the home country be "large" relative to its trade partners, its imposition of a tariff on imports would lead to an increase in domestic welfare if the terms of the trade rectangle exceed the sum of the
A) revenue effect plus redistribution effect.
B) protective effect plus revenue effect.
C) consumption effect plus redistribution effect.
D) production distortion effect plus consumption distortion effect.
E) terms of trade gain.

Question

Quizplus · Accepted Answer

The correct answer is D) production distortion effect plus consumption distortion effect. Imposing a tariff can lead to an increase in domestic welfare if the terms of trade gain (improvement in the price of exports relative to imports) exceeds the sum of the production distortion effect (inefficient allocation of resources towards the production of goods now protected by the tariff) and the consumption distortion effect (changes in consumption patterns away from what would be optimal without the tariff). This is because the terms of trade gain can offset the welfare losses from distortions in production and consumption, leading to a net increase in domestic welfare.

Should the Home Country Be "Large" Relative to Its Trade