Chapter 15

APPLIED COMPETITIVE ANALYSIS

MICROECONOMIC THEORY

BASIC PRINCIPLES AND EXTENSIONS EIGHTH EDITION

WALTER NICHOLSON

Copyright ©2002 by South-Western, a division of Thomson Learning. All rights reserved.

Gains from International Trade Price P*

S

In the absence of international trade, the domestic equilibrium price would be

P

* and the domestic equilibrium quantity would be

Q

*

D

Quantity Q*

Gains from International Trade Price

S

If the world price (

P W

) is less than the domestic price, the price will fall to

P W

P*

Quantity demanded will rise to

Q

1 and quantity supplied will fall to

Q

2

P W

Imports =

Q

1 -

Q

2

D

Quantity

Q

2 Q*

Q

1 imports

Gains from International Trade Price

S

Consumer surplus rises Producer surplus falls

P*

P W

There is an unambiguous welfare gain

D

Quantity

Q

1 Q*

Q

2

Price

P R P W

Effects of a Tariff

S

Suppose that the government creates a tariff that raises the price to

P R

Quantity demanded falls to

Q

3 and quantity supplied rises to

Q

4 Imports are now

Q

3 -

Q

4

D

Quantity

Q

2

Q

4

Q

3

Q

1 imports

Price

P R P W

Effects of a Tariff

D S

Consumer surplus falls Producer surplus rises The government gets tariff revenue These two triangles represent deadweight loss

Quantity

Q

2

Q

4

Q

3

Q

1

Estimates of Deadweight Losses

• Estimates of the sizes of the welfare loss triangle can be calculated • Because

P R

= (1+

t

)

P W

, the proportional change in quantity demanded is

Q

3 

Q

1

Q

1 

P R



P W P W



e D



te D

Price

P R P W

Effects of a Tariff

S

The areas of these two triangles are

DW

1  0 .

5 (

P R



P W

)(

Q

1 

Q

3 )

DW

1   0 .

5

t

2

e D P W Q

1

D

DW

2  0 .

5 (

P R



P W

)(

Q

4 

Q

2 )

DW

2   0 .

5

t

2

e S P W Q

2

Quantity

Q

2

Q

4

Q

3

Q

1

Other Trade Restrictions

• A quota that limits imports to

Q

3 -

Q

4 would have effects that are similar to those for the tariff – same decline in consumer surplus – same increase in producer surplus • One big difference is that the quota does not give the government any tariff revenue – the deadweight loss will be larger

Important Points to Note:

• The concepts of consumer and producer surplus provide useful ways of analyzing the effects of economic changes on the welfare of market participants – changes in consumer surplus represent changes in the overall utility consumers receive from consuming a particular good – changes in long-run producer surplus represent changes in the returns product inputs receive

Important Points to Note:

• Price controls involve both transfers between producers and consumers and losses of transactions that could benefit both consumers and producers

Important Points to Note:

• Tax incidence analysis concerns the determination of which economic actor ultimately bears the burden of the tax – this incidence will fall mainly on the actors who exhibit inelastic responses to price changes – taxes also involve deadweight losses that constitute an excess burden in addition to the burden imposed by the actual tax revenues collected

Important Points to Note:

• Transaction costs can sometimes be modeled as taxes – both taxes and transaction costs may affect the attributes of transactions depending on the basis on which the costs are incurred

Important Points to Note:

• Trade restrictions such as tariffs or quotas create transfers between consumers and producers and deadweight losses of economic welfare – the effects of many types of trade restrictions can be modeled as being equivalent to a per-unit tariff