PricePT=1.75
PW=1.50
PT*=1.2550556070Quantity
Figure 8-1
where the areas in the figure are:
a: 55(1.75-1.50) -.5(55-50)(1.75-1.50)=13.125
b: .5(55-50)(1.75-1.50)=0.625
c: (65-55)(1.75-1.50)=2.50
d: .5(70-65)(1.75-1.50)=0.625
e: (65-55)(1.50-1.25)=2.50
Consumer surplus change: -(a+b+c+d)=-16.875. Producer surplus change: a=13.125. Government revenue change: c+e=5. Efficiency losses b+d are exceeded by terms of trade gain e. [Note: in the calculations for the a, b, and d areas a figure of .5 shows up. This is because we are measuring the area of a triangle, which is one-half of the area of the rectangle defined by the product of the horizontal and vertical sides.]
4. Using the same solution methodology as in problem 3, when the home country is very small
relative to the foreign country, its effects on the terms of trade are expected to be much less. The small country is much more likely to be hurt by its imposition of a tariff. Indeed, this intuition is shown in this problem. The free trade equilibrium is now at the price $1.09 and the trade volume is now $36.40.
With the imposition of a tariff of 0.5 by Home, the new world price is $1.045, the internal home price is $1.545, home demand is 69.10 units, home supply is 50.90 and the volume of trade is 18.20. When Home is relatively small, the effect of a tariff on world price is smaller