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1. Describe the situation in the market for a good or service that the United States imports. The goods and services the United States will import are those in which the United States has a higher opportunity cost of production relative to other countries. In those markets the U.S. notrade price is higher than the world price. With trade the quantity produced in the United States is less than the quantity consumed and the difference is imported.
2. Describe the situation in the market for a good or service that the United States exports. The goods and services the United States will export are those in which the United States has a lower opportunity cost of production relative to other countries. In those markets the U.S. notrade price is lower than the world price. With trade the quantity produced in the United States exceeds the quantity consumed and the excess is exported.
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1. How is the gain from imports distributed between consumers and domestic producers? Consumers gain consumer surplus from imports and domestic producers lose producer surplus from imports.
2. How is the gain from exports distributed between consumers and domestic producers? Consumers lose consumer surplus from exports and domestic producers gain producer surplus from exports.
3. Why is the net gain from international trade positive?
The net gain from international trade is positive because the gain to the winners exceeds the losses to the losers. For instance, in the case of an imported good, all the loss of producer surplus is transferred to consumers as consumer surplus. In addition, however, consumers also
gain additional consumer surplus from the units imported. The total gain of consumer surplus exceeds the loss of producer surplus so that the net surplus increases. The situation is similar for exports: The total gain of producer surplus exceeds the loss of consumer surplus.
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1. What are the tools that a country can use to restrict international trade?
A country can use tariffs, import quotas, other import barriers such as health, safety, and regulation barriers, and voluntary export restraints to restrict international trade. Export subsidies given by a nation decrease other countries’ exports and thereby restrict their international trade.
2. Explain the effects of a tariff on domestic production, the quantity bought, and the price. A tariff raises the domestic price of the product. The higher price increases domestic production and decreases the domestic quantity purchased
3. Explain who gains and who loses from a tariff and why the losses exceed the gains. Domestic consumers lose consumer surplus from the tariff. Domestic producers gain producer surplus from the tariff. The government also gains revenue from the tariff. But the gain in producer surplus plus the gain in government revenue is less than the loss of consumer surplus, so on net a tariff creates a deadweight loss.
4. Explain the effects of an import quota on domestic production, consumption, and price. An import quota raises the domestic price of the product. The higher price increases domestic production and decreases domestic purchases.
5. Explain who gains and who loses from an import quota and why the losses exceed the gains.
Domestic consumers lose consumer surplus from the import quota. Domestic producers gain producer surplus from the import quota. The importers also gain additional profit from the import quota. But the gain in producer surplus plus the importers’ profits is less than the loss of consumer surplus, so on net an import quota creates a deadweight loss.
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1. What are the infant industry and dumping arguments for protection? Are they correct? The attempt to stimulate the growth of new industries is the infant-industry argument for protection, which states that it is necessary to protect a new industry from import competition to facilitate the growth of that industry, making it competitive in the world markets. This argument is based on the idea that as firms mature they become more productive. However this argument for protection only works if the benefits also spill over into other industries and other parts of the economy. This is rarely the case, as the entrepreneurs of infant industries and their financial supporters take this risk into account and all returns usually accrue only to them, not to other industries. And it is more efficient to subsidize the infant industry needing protection than it is to protect it by restricting trade.
The dumping argument for protection states that a foreign firm is selling its exports at a lower price than its cost of production. Foreign firms trying to monopolize the international market may use this practice. Once the competition is gone, the foreign firm will raise prices and reap profits. This argument fails for several reasons. First, it is virtually impossible to detect the occurrence of dumping since it is impossible to verify a firm’s production costs. The test most commonly used is if the firm’s price when it exports is lower than its domestic price. This test
only examines the supply side of the two markets and ignores the demand side. If the domestic market is inelastic and the export market is elastic (which is almost always the case) then it is natural for a firm to price the domestic goods higher than the exports. Second, it is difficult to see how a global firm could have a monopoly for the goods or services it exports. There are too many foreign suppliers (and potential suppliers), making global competition too extensive for a monopoly to exist in the global market. And, even if there is global monopoly it is more efficient to regulate it than to impose trade restrictions on its products.
2. Can protection save jobs and the environment and prevent workers in developing countries from being exploited?
There are many myths about trade restrictions. The problem mentions three of them, all false reasons often offered as reasons to restrict international trade. These arguments are:
Trade restrictions save domestic jobs: Free international trade does, indeed, cost jobs in the import-competing markets. But this argument ignores the fact that, under free trade, consumers in the exporting country will have greater disposable income. These consumers will use part of their higher income to buy goods and services from other countries, thereby increasing employment in the exporting sector of the nation. So, although international trade rearranges jobs decreasing them in import-competing markets and increasing them in exporting markets it does not, on net, cost jobs.
Trade restrictions penalize lax environmental standards: Not all developing countries have lax environmental standards. Also, a clean environment is a normal good. Countries that are relatively poor and have lax pollution standards do not care as much about the environment because imposing clean air, water, and land standards have a high opportunity cost because they will slow economic development. The best way to encourage environmental quality is not to restrict economic development but to encourage rapid economic growth, which will more quickly increase citizen demand for a cleaner environment in those developing countries.
Trade restrictions prevent rich countries from exploiting poorer countries: Importing goods made in countries with low wage levels increases the demand for labor in those countries, increasing the number of jobs available and raising wages over time. The more free trade that occurs with these countries, the more quickly the wages will rise and the working conditions will increase in quality and safety.
3. What is offshore outsourcing? Who benefits from it and who loses?
Offshore outsourcing occurs when a firm in the United States buys finished goods, components, or services from firms in other countries. Workers who have skills for jobs that have been sent abroad lose from offshore outsourcing. Consumers who consume the goods and services produced abroad and imported into the United States benefit.
4. What are the main reasons for imposing a tariff?
There are two main reasons for imposing tariffs on imports. First the government receives tariff revenues from imports, which can be useful when revenues from income taxes and sales taxes are less effective ways of gaining government revenue. Second rent seeking by individuals in industries that would be hurt by foreign competition can influence the government to impose tariffs
5. Why don’t the winners from free trade win the political argument?
Trade restrictions are enacted despite the inherent inefficiency because of the political actions of rent seeking groups, which fear that foreign competition might have a negative impact on their industry, firm, or jobs. The anti-trade groups are easily organized and have much to gain from
trade restrictions, whereas the vast millions of consumers, who would win from free trade, are difficult to organize because each individual has only a small amount of loss when trade restrictions are imposed. Hence the winners from trade restrictions frequently out-lobby the winners from free trade.
Use the following data to work Problems 1 to 3.
Wholesalers buy and sell roses in containers that hold 120 stems. The table provides information about the wholesale market for roses in the United States. The demand schedule is the wholesalers’ demand and the supply schedule is the U.S. rose growers’ supply. Wholesalers can buy roses at auction in Aalsmeer, Holland, for $125 per container.
1. a. Without international trade, what would be the price of a container of roses and how many containers of roses a year would be bought and sold in the United States?
Without international trade, in the United States the price of a container of roses is $175 and 6 million containers of roses are bought and sold.
b. At the price in your answer to part (a), does the United States or the rest of the world have a comparative advantage in producing roses?
The price of roses in the United States exceeds the price in the rest of the world, so the rest of the world has a comparative advantage in producing roses.
2. If U.S. wholesalers buy roses at the lowest possible price, how many do they buy from U.S. growers and how many do they import?
The price of roses in the United States is $125 per container. At this price, U.S. rose growers supply 2 million containers per year and U.S. wholesalers demand 12 million containers of roses. U.S. wholesalers buy the 2 million containers from U.S. growers and purchase 10 million containers from foreign sources, which are imported into the United States.
3. Draw a graph to illustrate the U.S. wholesale market for roses. Show the equilibrium in that market with no international trade and the equilibrium with free trade. Mark the quantity of roses produced in the United States, the quantity imported, and the total quantity bought.
In Figure 7.1, the equilibrium without international trade is determined at the intersection of the demand curve and the supply curve. Without international trade the equilibrium price is $175 per container and 6 million containers per year are bought and produced. With international trade the world price is $125 per container, as shown in Figure 7.1. The quantity produced in the United States is 2 million containers and the quantity bought in the United States is 12 million containers. Imports into the United States
account for the difference between the quantity bought and the quantity produced, 10 million containers.
4. Use the information on the U.S. wholesale market for roses in Problem 1 to
a. Explain who gains and who loses from free international trade in roses compared to a situation in which Americans buy only roses grown in the United States. U.S. rose wholesalers, who are the consumers in the problem, gain from free international trade. U.S. rose growers lose from free international trade.
b. Draw a graph to illustrate the gains and losses from free trade. Figure 7.2 illustrates the market with free trade. Consumer surplus before international trade is equal to area A; after international trade consumer surplus is equal to area A + area B + area C. Producer surplus before international trade is equal to area B + area D; after international trade producer surplus is equal to area D
c. Calculate the gain from international trade. The gain from international trade is area C in Figure 7.2. It is equal to ½ ($175 $125) (10 million containers) which is $250 million.
Use the information on the U.S. wholesale market for roses in Problem 1 to work Problems 5 to 10.
5. If the United States puts a tariff of $25 per container on imports of roses, explain how the U.S. price of roses, the quantity of roses bought, the quantity produced in the United States, and the quantity imported changed. The U.S. price of roses rises from $125 per container (the price with free trade) to $150 per container. The quantity of roses produced in the United States increases from 2 million containers (the quantity produced with free trade) to 4 million containers. The quantity of roses consumed in the United States decreases from 12 million containers (the quantity consumed with free trade) to 9 million containers. The quantity imported decreases from 10 million containers to 5 million containers.
6. Who gains and who loses from this tariff?
U.S. rose consumers lose from the tariff. U.S. rose producers gain from the tariff. The U.S. government gains revenue from the tariff.
7. Draw a graph of the U.S. market for roses to illustrate the gains and losses from the tariff and on the graph identify the gains and losses, the tariff revenue, and the deadweight loss created.
Figure 7.3 shows the effect of the tariff. The amount of the tariff per container is equal to the height of the light gray arrow. Before the tariff U.S. consumer surplus was equal to area A + area B + area C + area E + area F. After the tariff U.S. consumer surplus is equal to area A. U.S. consumers lose consumer surplus equal to area B + area C + area E + area F Before the tariff U.S. producer surplus was equal to area G. After the tariff U.S. producer surplus is equal to area G + area B. U.S. producers gain producer surplus equal to area B. After the tariff the U.S. government gains tariff revenue equal to area E. The deadweight loss from the tariff is equal to area C + area F
8 If the United States puts an import quota on roses of 5 million containers, what happens to the U.S. price of roses, the quantity of roses bought, the quantity produced in the United States, and the quantity imported?
The U.S. price of roses rises to $150 per container. 9 million containers of roses are purchased in the United States and 4 million containers of roses are produced in the United States. The difference, 5 million containers, is imported into the United States.
9 Who gains and who loses from this quota?
U.S. rose growers and importers of roses gain from the quota. U.S. rose wholesalers lose from the quota.
10 Draw a graph to illustrate the gains and losses from the import quota and on the graph identify the gains and losses, the importers’ profit, and the deadweight loss. Figure 7.4 shows the effect of the import quota. The amount of the quota is equal to the length of the gray arrow. Before the quota U.S. consumer surplus was equal to area A + area B + area C + area E + area F. After the quota U.S. consumer surplus is equal to area A. U.S. consumers lose consumer surplus equal to area B + area C + area E + area F. Before the quota U.S. producer surplus was equal to area G. After the quota U.S. producer surplus is equal to area G + area B. U.S. producers gain producer surplus equal to area B. After the quota the
importers of the rose containers earn profit equal to area E. The deadweight loss from the import quota is equal to area C + area F.
U.S. regulators ordered the recall of more than 450,000 faulty tires. The Chinese producer of the tires disputed the allegations and hinted that the recall might be an effort to hamper Chinese exports to the United States.
Source: International Herald Tribune, June 26, 2007
a. What does the news clip imply about the comparative advantage of producing tires in the United States and China?
Because the tires were produced in China, the news clip suggests that China has the comparative advantage in producing tires.
b. Could product quality be a valid argument against free trade? If it could, explain how. Product quality is not a valid argument against free trade. Quality is a valid concern for consumers. If consumers cannot judge quality themselves, then government inspection might be necessary. But in that case government inspection of both imported and domestically produced goods is required. To single out imported goods or services makes little sense. And, by questioning the quality of tires, U.S. producers create questions in the minds of U.S. consumers regarding the safety of imported tires, thereby increasing the demand for domestically produced tires.
12. Suppose that the world price of sugar is 10 cents a pound, the United States does not trade internationally, and the equilibrium price of sugar in the United States is 20 cents a pound. The United States then begins to trade internationally.
a. How does the price of sugar in the United States change?
The price of sugar in the United States falls.
b. Do U.S. consumers buy more or less sugar?
As a result of the lower price, U.S. consumers buy more sugar.
c. Do U.S. sugar growers produce more or less sugar?
As a result of the lower price, U.S. growers produce less sugar
d. Does the United States export or import sugar and why?
The United States imports sugar. The quantity of sugar demanded increases while quantity supplied decreases. The difference is made up by imports.
13. Suppose that the world price of steel is $100 a ton, India does not trade internationally, and the equilibrium price of steel in India is $60 a ton. India then begins to trade internationally.
a. How does the price of steel in India change?
The price of steel in India rises to equal the world price.
b. How does the quantity of steel produced in India change?
Producers respond to the higher price by increasing the quantity of steel produced.
c. How does the quantity of steel bought by India change?
Steel users in India respond to the higher price by decreasing the quantity of steel bought.
d. Does India export or import steel and why?
Because the price of steel in India is lower than the world, India has a comparative advantage in the production of steel. India will export steel.
14. A semiconductor is a key component in your laptop, cell phone, and iPod. The table provides information about the market for semiconductors in the United States. Producers of semiconductors can get $18 a unit on the world market.
a. With no international trade, what would be the price of a semiconductor and how many semiconductors a year would be bought and sold in the United States?
With no international trade the price of a semiconductor in the United States is $12 per unit. 20 billion units are bought and sold in the United States.
b. Does the United States have a comparative advantage in producing semiconductors?
The United States has a comparative advantage in producing semiconductors because the U.S. price is lower than the price in the world market.
15. Act Now, Eat Later
The hunger crisis in poor countries has its roots in U.S. and European policies of
subsidizing the diversion of food crops to produce biofuels like corn-based ethanol. That is, doling out subsidies to put the world’s dinner into the gas tank.
Source: Time, May 5, 2008
a. What is the effect on the world price of corn of the increased use of corn to produce ethanol in the United States and Europe?
The use of corn to produce ethanol increased the demand for corn, thereby raising the price of corn.
b. How does the change in the world price of corn affect the quantity of corn produced in a poor developing country with a comparative advantage in producing corn, the quantity it consumes, and the quantity that it either exports or imports?
The higher world price of corn decreases the consumption of corn and increases the production of corn in poor developing countries. Because the country has a comparative advantage it will export corn. The higher price leads the country to increase its exports.
16. Draw a graph of the market for corn in the poor developing country in Problem 15(b) to show the changes in consumer surplus, producer surplus, and deadweight loss.
Figure 7.5 shows the situation in the poor country that exports corn. With the initial lower price, the country produces 60 million bushels, exports 20 million bushels, and consumes 40 million bushels. The consumer surplus is equal to area A + area B and the producer surplus is equal to area E. After the world price of corn rises to $8 per bushel, the country produces 80 million bushels of corn, exports 60 million bushels, and consumes 20 million bushels. Consumer surplus decreases to area A and producer surplus increases to area B + area C + area E. There is no deadweight loss; in fact, the country gains additional surplus equal to area C
Use the following news clip to work Problems 17 and 18.
South Korea will reopen its market to most U.S. beef. South Korea banned imports of U.S. beef in 2003 amid concerns over a case of mad cow disease in the United States. The ban closed what was then the third-largest market for U.S. beef exporters.
Source: CNN, May 29, 2008
17. a. Explain how South Korea’s import ban on U.S. beef affected beef producers and consumers in South Korea.
The South Korean ban raised the price of beef in South Korea. The higher price led to increased production in South Korea, which made South Korean producers better off. The higher price also led to decreased consumption in South Korea, which made South Korean consumers worse off.
b. Draw a graph of the market for beef in South Korea to illustrate your answer to part (a) Identify the changes in consumer surplus, producer surplus, and deadweight loss.
Figure 7.6 shows the effect of South Korea’s import ban. Prior to the ban the price of beef in South Korea was $4 per pound. At this price the quantity consumed in South Korea was 12 million tons of beef per year and the quantity produced in South Korea was 2 million tons of beef per year. The difference, 10 million tons of beef per year, was imported from the United States. Consumer surplus in South Korea was equal to area A + area B + area C and producer surplus in South Korea was equal to area E. With the import ban, the price of beef in South Korea rises to $6 per pound. At this price 6 million tons of beef per year are consumed in South Korea and 6 million tons of beef per year are produced in South Korea. There are no imports. Consumer surplus is South Korea shrinks to only area A and producer surplus grows to equal area B + area E. There is now a deadweight loss which is equal to area C.
18. a. Assuming that South Korea is the only importer of U.S. beef, explain how South Korea’s import ban on U.S. beef affected beef producers and consumers in the United States. South Korea’s ban meant that the United States no longer exported beef. (Recall the assumption that South Korea is the only importer of U.S. beef.) In the United States the price of beef falls to the no-trade price. U.S. consumption increases and U.S. production decreases so U.S. consumers are better off and U.S. producers are worse off.
b. Draw a graph of the market for beef in the United States to illustrate your answer to part (a) Identify the changes in consumer surplus, producer surplus, and deadweight loss.
Figure 7.7 shows the situation in the U.S. market for beef. With trade the price of beef is $4 per pound. The United States produces 30 million pounds of beef, consumes 20 million pounds of beef, and exports the difference. At this price consumer surplus in the United States is equal to area A and producer surplus is equal to area B + area C + area E. When South Korea eliminates U.S. exports, the price falls to $3.50 per pound, the no-trade price. U.S. consumer surplus increases from area A to area A + area B. U.S. producer surplus falls from area B + area C + area E to only area E. The deadweight loss equals area C
Before 1995, trade between the United States and Mexico was subject to tariffs. In 1995, Mexico joined NAFTA and all U.S. and Mexican tariffs have gradually been removed.
19. Explain how the price that U.S. consumers pay for goods from Mexico and the quantity of U.S. imports from Mexico have changed. Who are the winners and who are the losers from this free trade?
With NAFTA, the prices that U.S. consumers pay for goods from Mexico have fallen and, as a result, the quantity of imports from Mexico have increased. Winners from this free trade are Mexican producers of goods exported to the United States and U.S. consumers of these goods. Losers are Mexican consumers of the goods and U.S. producers of the goods.
20. Explain how the quantity of U.S. exports to Mexico and the U.S. government’s tariff revenue from trade with Mexico have changed.
The prices of U.S. goods in Mexico have fallen and, as a result, the quantity of U.S. goods exported to Mexico has increased. The U.S. government’s tariff revenue from tariffs imposed on trade with Mexico decreased.
21. Suppose that in 2015 tomato growers in Florida lobby the U.S. government to impose an import quota on Mexican tomatoes. Explain who in the United States would gain and who would lose from such a quota.
U.S. tomato growers gain from such a quota. The importers who hold the quota rights also gain. U.S. consumers of tomatoes lose from such a quota.
Use the following information to work Problems 22 and 23. Suppose that in response to huge job losses in the U.S. textile industry, Congress imposes a 100 percent tariff on imports of textiles from China.
22. Explain how the tariff on textiles will change the price that U.S. buyers pay for textiles, the quantity of textiles imported, and the quantity of textiles produced in the United States.
The tariff raises the U.S. price of textiles. As a result, the quantity of textiles consumed in the United States decreases and the quantity produced increases. Imports of textiles into the United States decrease.
23. Explain how the U.S. and Chinese gains from trade will change. Who in the United States will lose and who will gain?
The decrease in trade means that the U.S. and Chinese gains from trade decrease. In the United States, U.S. producers gain from the tariff. The U.S. government also gains revenue from the tariff. U.S. textile consumers lose.
Use the following information to work Problems 24 and 25.
With free trade between Australia and the United States, Australia would export beef to the United States. But the United States imposes an import quota on Australian beef.
24. Explain how this quota influences the price that U.S. consumers pay for beef, the quantity of beef produced in the United States, and the U.S. and the Australian gains from trade. The quota raises the price of beef in the United States. By raising the U.S. price, the quota increases the quantity of beef produced in the United States and decreases the quantity of beef consumed in the United States. The U.S. and Australian gains from trade decrease.
25. Explain who in the United States gains from the quota on beef imports and who loses. U.S. beef producers gain from the quota. The people who hold the import quota rights also gain. U.S. beef consumers lose from the quota.
The cost of protecting jobs in uncompetitive sectors through tariffs is high: Saving a job in the sugar industry costs American consumers $826,000 in higher prices a year; saving a dairy industry job costs $685,000 per year; and saving a job in the manufacturing of women’s handbags costs $263,000.
Source: The New York Times, June 26, 2006
a. What are the arguments for saving the jobs mentioned in this news clip? Explain why these arguments are faulty.
The arguments for saving these jobs are (explicitly) the argument that protection saves jobs and (implicitly) that protection allows us to compete with cheap foreign labor.
The fact these arguments are wrong can be demonstrated by comparing the cost of saving a job to the wage paid on the job. The cost to U.S. consumers of saving a job massively outweighs the benefit of a job to the worker, that is, the wage rate paid on the job. This empirical result demonstrates the conclusion that the cost of protection to the losers, U.S. consumers, exceeds the gain to the winners, U.S. producers.
b Is there any merit to saving these jobs?
There is merit to the workers whose jobs are saved and who might not receive any government assistance if their jobs are not protected. There also is merit to the politicians who can obtain a reward from lobbyists for the protection. There is no merit, however, to society as a whole.
27. After you have studied Economics in the News on pp. 168–169, answer the following questions.
a. What is the TPP?
The TTP is the Trans Pacific Partnership, a trade agreement among 12 nations.
b. Who in the United States would benefit and who would lose from a successful TPP?
U.S. exporters of goods whose tariffs are reduced and U.S. consumers of imported goods whose tariffs are reduced benefit from a successful TPP. U.S. consumers of exported goods whose tariffs are reduced and U.S. producers of imported goods whose tariffs are reduced lose from a successful TPP. The government might gain or lose tariff revenue depending on the magnitudes of the consumption and production changes.
c. Illustrate your answer to part (b) with an appropriate graphical analysis assuming that tariffs are not completely eliminated
Figure 7.8a (on the next page) shows the effect in the United States of lowering the U.S. tariff on a good. Initially the price in the United States was $90 per unit. Consumer surplus was equal to area A and producer surplus was equal to area B + area F When the tariff is lowered, the price in the United States becomes $70 per unit. Consumer surplus increases and equals area A + area B + area C. Producer surplus, however, decreases to area F. The government’s tariff revenue equals area E
Figure 7.8b (on the next page) shows the effect in the United States of lowering the Japanese tariff on rice. Initially the price in the United States was $300 per ton. Consumer surplus was equal to area A + area B and producer surplus was equal to area E. When the tariff is lowered so that the Japanese now import rice, the price in the United States rises to become the world price of $500 per ton. Consumer surplus decreases and equals area A. Producer surplus, however, increases to area B + area C + area E
d. Who in Japan and other TPP nations would benefit and who would lose from a successful TPP?
In other TPP nations and particularly in Japan, consumers of rice and other farm products would benefit from a successful TPP. In other TPP nations and particularly in Japan, producers of rice and other farm products would lose from a successful TPP. The Japanese government would lose tariff revenue
e. Illustrate with an appropriate graphical analysis who in Japan would benefit and who would lose from a successful TPP assuming that all Japan's import quotas and tariffs are completely eliminated.
Figure 7.9 shows the effect in Japan of eliminating Japan’s tariffs and import quotas. Figure 7.9 shows the effect in the market for rice; the effect in other markets is similar. Before the tariffs and import quotas are eliminated, the price in Japan was $700 per ton of rice. The consumer surplus is equal to area A, the producer surplus was equal to area B + area C and the government’s tariff revenue (and/or importers’ economic profit) was equal to area E After the tariffs and import quotas are removed, the price falls to $500 per ton of rice. Consumer surplus increases and equals area A + area B + area F + area E + area G. Producer surplus, however, decreases to area C. The government’s tariff revenue (and/or importers’ economic profit) disappears. Consumers benefit because their consumer surplus increases; producers lose because their producer surplus decreases; the government (and/or importers) loses because their tariff revenue (or economic profit) is eliminated.
Italy has dropped its resistance to a E.U. trade agreement with South Korea, which will wipe out $2 billion in annual duties on E.U. exports. Italians argued that the agreement, which eliminates E.U. duties on South Korean cars, would put undue pressure on its own automakers.
Source: The Financial Times, September 16, 2010
a. What is a free trade agreement? What is its aim?
A free trade agreement is an agreement among nations that they will not impose tariffs, quotas, or other protectionist policies on each other’s imports.
b. Explain how a tariff on E.U. car imports changes E.U. production of cars, purchases of cars, and imports of cars. Illustrate your answer with an appropriate graphical analysis.
The tariff that was imposed by the European Union decreased E.U. imports of cars. It raised the price of cars in the European Union, thereby increasing production of cars in the European Union and decreasing purchases of cars in the European Union. In Figure 7.10, the world price is $20,000 per car and the E.U. tariff is $2,500 per car. The price in the European Union is $22,500 per car. The quantity produced in the European Union is 20,000 cars per year and the quantity purchased is 42,333 per year so that 22,333 cars per year are imported. If there was no tariff, so that the price in the European Union was equal to the world price, the quantity produced in the European Union would be 10,000 and the quantity purchased would be 60,000 so that 50,000 cars per year are imported.
c. Show on your graph the changes in consumer surplus and producer surplus that result from free trade in cars.
Figure 7.11 shows how the consumer surplus and producer surplus change if the E.U. tariff is eliminated. With the tariff in place, the consumer surplus equals area A and the producer surplus equals area B + area E. If the tariff is eliminated, the price in the European Union falls to $20,000 per car. Consumer surplus increases the area A + area B + area C. Producer surplus decreases to area E.
d. Explain why Italian automakers opposed cuts in car import tariffs.
Italian automakers opposed cuts in the tariff because they knew that if the tariff was cut,
the price of cars in Italy would fall, thereby decreasing their producer surplus