In the text, we argued that the burden of tariffs is shifted across markets in ways that

Question:

In the text, we argued that the burden of tariffs is shifted across markets in ways that are analogous to how tax burdens are shifted between consumers and producers.

A. Consider two countries—country 1 in which product x would sell at p¹ and country 2 in which it would sell at p₂ in the absence of any trade between the countries. Suppose throughout that p² > p¹.

(a) Begin by illustrating the free trade equilibrium assuming negligible transportation costs.

(b) Illustrate how the imposition of an import tax (or tariff ) of t per unit of x by country 2 changes the equilibrium.

(c) What in your answer to (b) would change if, instead of country 2 imposing a per unit import tax of t , country 1 had imposed a per unit export tax of the same amount t ?

(d) In your graph, illustrate the economic incidence of the tax t on trade; i.e. illustrate how much of the overall tax revenue is raised from country 1 and how much is raised from country 2.

(e) How would your answer change if you made the supply curve in country 1more elastic while keeping p¹ unchanged? What if you made the demand curve more elastic?

(f ) In Chapter 19, we argued that it does not matter whether a per-unit tax is imposed on producers or on consumers within a market — the economic impact will be the same. How is what you have found in this exercise analogous to this result?

(g) If the supply curves in country 1 were perfectly inelastic, would any of the tariff be paid by country 2?

Graph 20.2: Economic Incidence of Tariffs with perfectly inelastic Supply in Country 1

B. Now consider demand and supply functions

for country 1 and

for country 2 (as in part B of the text.)

(a) Set up an Excel spreadsheet that calculates production and consumption levels in each country as a function of the demand and supply parameters A, B, α, β, C, D, γ and δ as well as the per-unit tariff t imposed by country 2. Would any of your spreadsheet differ if instead we analyzed a per-unit export tax in country 1?

(b) Let A = 1000 = C, α = β = 1 = γ = δ, B = 0 and D = −400. Verify that you get the same result as what is reported in part B of the text for the same parameters when t = 0 and when t = 100.

(c) Set up a table in which the rows correspond to scenarios where we change the parameters B and β from (49500,100) in the first row to (12000,25), (2000,5), (500,2), (0,1), (−250,0.5), (−375,0.25), (−450,0.1), and (−495,0.01) in the next 8 rows. Then report in each row p¹ and x¹ —the price and quantity in country 1 in the absence of trade; p^∗ = p˜1 = p˜² — the world price under free trade; X^∗ —the level of exports under free trade; X^∗(t )—the level of exports when t = 100 is imposed; p˜¹(t ) and p˜²(t ) — the prices when a per unit tariff of t = 100 is imposed; and the fraction k of the tariff that is shifted to country 1.

(d) Explain what is happening as we move down the rows in your table.

(e) Next, set up a table in which the rows correspond to scenarios where we change the parameters A and α from (50500,100) in the first row to (13000,25), (3000,5), (1500,2), (1000,1), (750,0.5), (625,0.25), (550,0.1), and (505,0.01) in the next 8 rows. (Keep the remaining parameters as originally specified in (b).) Then report the same columns as you did in the table you constructed for part (c).

(f) Are there any differences between your two tables? Explain.