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Week 6

by: Hewan Ft

Week 6 ECON 270

Hewan Ft

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the second half of the trade final notes
International economics
Bob Horn
Class Notes
Economics, International
25 ?




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This 7 page Class Notes was uploaded by Hewan Ft on Friday October 7, 2016. The Class Notes belongs to ECON 270 at James Madison University taught by Bob Horn in Fall 2016. Since its upload, it has received 6 views. For similar materials see International economics in Economics at James Madison University.


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Date Created: 10/07/16
Econ 270­ Week 6 Compare between small country and large country model. When a large country imports something, it will have a significant effect of the world market. If free trade price is PW (with perfectly elastic supply) aka world price  If there was a 3 dollar tariff, but if the consumers would not pay the full 13 dollars. The supplier would absorb a portion of the tariff as a loss and raise the prices for a little bit less  than the tariff. PW* when the supplier sets the world price at a lower amount but increase the price. If the price went from 10 ­> $9 and then adding the tariff of $3 to so consumers would pay  $12.00 ­ They yellow box would be the tariff revenues from the consumers of the country. ­ And the red box would be the tariff cost paid by the suppliers­ therefore the tariff  revenue are not totally being taken from the consumers but the suppliers had to pay a  portion of it. Ex. 2 Qd= 300 ­ 20 p Qs= ­100+ 30p Pft= $ 5 and the tariff = $1 So if the tariff is split 1= .6 (paid by consumers) and .4 (paid by producers)   The Pw* = 5 ­ 0.6 =$ 4.6 (because the consumer would only be paying their portion and then we would plug that price in our demand equation) PW* (0.6) + T ($1)= 5.6 so consumers would be paying $5.6  Not that they are losing, they just would be making a bit less. If we are told that the tariff  going to be split, we know that it is a large country model. ­ Basic analysis is the same ­ The tariff still decreases the consumer plus ­ Transfer to producer surplus ­ Still have deadweight loss Effective rate of Protection:­ may be different than the nominal tariff on  finished goods. ERP= VA* ­ VA free trade(ft) / VA ft  Value Added:­ Is Pw for glasses = $200 The frames of these glasses are imported from italy= $50 each Everything else that we add to get them to market ($150) would be called value added Ex. materials, labour, advertising are all examples of value added (those made with the home  country) If Tariff 20% will be on imported glasses only. Raising the world price of glasses from $200 to $240. The domestic producers would be better off because they realize that people are willing to pay  $240 now instead $200 and so domestic producers who are not exporting and not pay the 40%  tariff are gaining $40. So with $50 of frames and the $240, the difference is the benefit of the producer is not $150 but  $190. ERP = 24% Why is the ERP higher than the VAT and if that good? This is not a good move for the economy because they are subsidising less efficient producers  who could not make as much profit at the regular trade price. If there was a 10% VAT on frames Free trade world price 20%   of tariff on  10% on a tariff on  ($) eyeglasses ($)  frames ($) Eye glasses 200 240 240 frames 50 50 50 VAT 150 190 185 So as a producer, we would want a VAT only on the item we are directly competing in, not on  the input. If a country wanted to completely do away with a market ( like glasses), the country would put  100% on frames. This would tell the producer to sell something else. The ERP would be in the  negatives or <0 Therefore the ERP depends on:­ ­ The nominal tariff rate ­ The % or amount of the imported components ­ The tariff on the imported components If on the other hand, we had  0 imported components? Therefore everything would be domestic. The VAT would be $240 The ERP and the VAT would be the same = 20% If 50% of the frame was imported 140­ 100/100= 40% Difference in Tariffs and Quotas Quotas are banned by WTO but not tariffs Still important because countries still have quotas despite the WTO Most but not all countries are members  If a country had quotas and then joined WTO the are given a certain amount of time to gradually remove it. Ex.1 If we put a quota on a small country. If the Q(quote) was 100 Therefore the total Quantity supplied  = amount we supply (on the supply chart) + the Quota At Pw our quantity supplied with the quote = Q1 + 100= Q3 PQ=  0 to Q3= total amount supplied (with the quota 0 to Q4 = domestic quantity supplied Green block= what was consumer surplus that is now producer surplus Blue block= the foreign country surplus   Ex 2. If 4 different companies want to export to a country with a quota of 2000 cars. The country bid to have the first 500 cars sold in the car. These countries would bid as high as  profitable to get the first rights to export. Ex 2 Qd=150­3P Qs= ­50 +2p P= 40 Q=30 Suppose the free trade price = 30 We know that with a price of 30 Quantity demanded = 60 (q2) If we have a quote of 20 Q1= 10 Q2= 60 Q3= 30 The quote gets added to the supply curve Sd + Q= ­50 + 2p +20 Sd+Q= 30+2p (red line ­quota) ­50 +2p+20 =30+2p P =36 To find quantity= we plug P into the Quota line = 42 Q3­ 42= Q4= 22 How much have the price gone up as a result of the quota= Quota rent  Quota revenue = 120 (6x20) Dead weight loss = ½ BH If we had to get rid of the quota and put in a tariff= what would we have to do? Aka what tariff would have us the same exact result as the quota (Tariff Equivalence) In the diagram above = $6 tariff Or in a percentage = Price (quota) ­ P (free trade) / P (free trade) =% tariff 36­30/30 = 20% Once the quota was converted into a tariff the center rectangle would change to tariff revenue  rather than foreign producer profit. So why Quota? *If it was a small country, and we have an increase in demand, world price would still be the  same because there is no effect of World price. If we had a tariff in place, same thing, no  change in Price of the good.  BUT if there was a quota in place, that means price will increase because, domestic supply and  demand both shift. Other restrictions:­ A­ Domestic Content rule: x% of the goods valued have to made in a home country Why protection? A­ Does this save jobs?  ­ No,not in total because trade only affects the distribution of jobs not the number  of jobs. B­ When a domestic industry is weak? ­ Infant industry argument­ aka startups need protection. Not a good enough  argument because it makes inefficient industries and companies become compliant. C­ Increases government revenue? ­ This was the best way for new america to make money but now it does not have  the same effect because the tariffs are not high enough and only make up a tiny portion  of the revenue. D­ National security?  ­ There is no sector that's important enough to be detrimental to the survival of the  nation. Intellectual property  ­ Price discrimination ex. Universities,drug companies


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