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Effective rates of protection

1. Suppose the free trade market price of a car is $10,000. It contains $5000 worth of steel. The importing country imposes 25% tariff on car imports.

a. Calculate the effective rate of protection if there is no duty on steel imports.

b. Calculate the effective rate of protection if the importing country imposes a 20% tariff on steel imports.

c. Suppose it also takes $2000 worth of copper (besides $5000 worth of steel) to produce a car. Calculate the effective rate of protection if there is no import tariff on the imports of either steel or copper.

d. Suppose there is import duty of 20% and 15% on imports of steel and copper, respectively. Calculate the effective tariff rate.

2. Ignoring the mathematics, explain the operation of the Krugman model in economic terms and indicate its principal lessons.

Solution Preview

1. Suppose the free trade market price of a car is $10,000. It contains $5000 worth of steel. The importing country imposes 25% tariff on car imports.
 
The effective rate of protection can be found from the value added of the final product under free trade and with the tariffs. We then divide the difference by the value added under free trade.
Calculate the effective rate of protection if there is no duty on steel imports.
Value added under free trade: 10000-5000 =5000
Value added under tariff: 10000(1+.25) -5000 = 7500
ERP = 7500-5000/5000=.5
Calculate the effective rate of protection if the importing country imposes a 20% tariff on steel ...

Solution Summary

Calculation of effective rates of protection with different inputs

$2.19