Q5. Imagine a developing country government that has 2 policy options with regard to the domestic...

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Q5. Imagine a developing country government that has 2 policy options with regard to the domestic automobile industry. The first one is that it promotes free trade, not imposing any tariffs and quotas. The other option is that it follows a policy of infant-industry protection, allowing the domestic production of automobiles to be sheltered by tariffs on imports. Consider evaluating this policy over 2 time periods. In period 1, there is "learning-by-doing", so the marginal cost decreases in period 2. The extent of reduction in MC in period 2 depends on the production of period 1 (and the amount of reduction under option 1 and option 2 are shown in the graphs below-S1 is the supply curve in time period 1, S2 is the supply curve in time period Option 1: Free Trade Price (S) 60 25 20 15 O 10 20 70 Quantity (thousand) Price (S) 60 30 25 20 0 Option 2: Tariff 10 20 38 60 70 Quantity (thousand) a) Calculate consumer surplus and producer surplus of free trade (option 1) in time period 1. b) Assume that the government imposes a tariff (option 2) in period 1. Calculate consumer surplus, producer surplus, government revenue and deadweight loss associated with this policy. If there is a DWL relative to free trade, then why does the government do this? c) Now let us see what happens in time period 2 under the 2 options. Calculate the consumer surplus and producer surplus under both policy options in period 2 (assume no tariffs in period 2). d) Add the total surplus in both time periods under both policy options. Which one is higher? Do you now see why a social planner might be willing to suffer a DWL (deadweight loss) in period 1 under option 2? Explain this in words. e) In this model, the optimal tariff in period 2 is always zero. Why? f) In practice, once a tariff was imposed in period 1, it was difficult to remove in later periods. Explain why this may be the case using the discussion in class about concentrated costs and diffuse benefits of free trade. Q5. Imagine a developing country government that has 2 policy options with regard to the domestic automobile industry. The first one is that it promotes free trade, not imposing any tariffs and quotas. The other option is that it follows a policy of infant-industry protection, allowing the domestic production of automobiles to be sheltered by tariffs on imports. Consider evaluating this policy over 2 time periods. In period 1, there is "learning-by-doing", so the marginal cost decreases in period 2. The extent of reduction in MC in period 2 depends on the production of period 1 (and the amount of reduction under option 1 and option 2 are shown in the graphs below-S1 is the supply curve in time period 1, S2 is the supply curve in time period Option 1: Free Trade Price (S) 60 25 20 15 O 10 20 70 Quantity (thousand) Price (S) 60 30 25 20 0 Option 2: Tariff 10 20 38 60 70 Quantity (thousand) a) Calculate consumer surplus and producer surplus of free trade (option 1) in time period 1. b) Assume that the government imposes a tariff (option 2) in period 1. Calculate consumer surplus, producer surplus, government revenue and deadweight loss associated with this policy. If there is a DWL relative to free trade, then why does the government do this? c) Now let us see what happens in time period 2 under the 2 options. Calculate the consumer surplus and producer surplus under both policy options in period 2 (assume no tariffs in period 2). d) Add the total surplus in both time periods under both policy options. Which one is higher? Do you now see why a social planner might be willing to suffer a DWL (deadweight loss) in period 1 under option 2? Explain this in words. e) In this model, the optimal tariff in period 2 is always zero. Why? f) In practice, once a tariff was imposed in period 1, it was difficult to remove in later periods. Explain why this may be the case using the discussion in class about concentrated costs and diffuse benefits of free trade.