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INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 1 ppf Tariff, general equilibrium X Y 0 U* C* Q* p world We consider.

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Presentation on theme: "INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 1 ppf Tariff, general equilibrium X Y 0 U* C* Q* p world We consider."— Presentation transcript:

1 INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 1 ppf Tariff, general equilibrium X Y 0 U* C* Q* p world We consider the situation for a country faced with the production possibility frontier as drawn in the figure below. small At the given world price p world it would produce at point Q* and trade at world prices to consume at point C*

2 INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 2 X Y 0 U* C* Q* p world If the country imposes a tariff, t, on its import good (good X) this rotates the price line for domestic producers clockwise to p world (1+t) They will start to produce at point Q 2 Q2Q2 p world (1+t) Tariff, general equilibrium

3 INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 3 X Y 0 U* C* Q* p world Despite the tariff the country can still trade with ROW at the price p world So the income available to the economy is represented by an income line parallel to the initial income line through the new production point Q2Q2 p world (1+t) Tariff, general equilibrium

4 INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 4 X Y 0 U* C* Q* p world Consumers, like producers, face the price p world (1+t) They equalize the marginal rate of substitution with the distorted price line along the new income line; a point like C 2 Q2Q2 p world (1+t) U2U2 C2C2 The difference in production and consumption income (domestic prices) represents tariff revenue We assume that this is redistributed lump-sum to the consumers Tariff, general equilibrium

5 INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 5 X Y 0 U* C* Q* p world Tariffs result in a double distortion. First, producers change production and thus income. Welfare U 1 at point C 1 is still attainable. Q2Q2 p world (1+t) U1U1 U2U2 C1C1 C2C2 Second, consumers are also confronted with distorted prices, which lowers welfare to U 2 Tariff, general equilibrium

6 INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 6 Here is an enlargement of the welfare loss arising from the tariff First, the production (income) loss Second, the consumption loss C* C1C1 U* U1U1 U2U2 C2C2 Check for yourself that the second loss does not arise if a production subsidy is given, rather than a tariff imposed. Tariff, general equilibrium


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