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International Economics: Free Trade Agreements

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Question 1a
Given that no free trade agreements are in effect with either Japan or Canada and that tariff is $1000, no American would buy the Canadian cars because they would cost $6500 (equal to the $5500 price charged by Canadian producers plus $1000 tariff). Hence, the US would trade only with Japan.

Question 1b
Supposing that a free trade agreement is in effect with Canada, the US would import only Canadian cars and none from Japan.

Question 1c
Trade creation will be greater than trade diversion, meaning trade creation dominates resulting to a net gain, when the partner country, in this case Canada, is the lowest-cost car producer.

Question 2a
The product's price after imposition of the tariff is $11,000
$10,000* (1+10%) = $11,000

Question 2b
The domestic value added before the tariff is $7,500 which is equal to the difference of the input materials, imported components, and the free trade price of the product.
$10,000 - ($10,000 * 25%) = $7,500

Question 2c
The domestic value added after the tariff is $8,375 which is the difference between the domestic price of $11,000 and the imported components cost of $2,625.
$11,000 - [$10,000 * 25% * (1+5%)] = $8,375

Question 2d
The effective rate of protection is 11.67% which is greater than the nominal rate of 10%.
$8,375 - $7,500 = $875
$875/$7,500 * 100 = 11.67%

Question 2e
A tariff can understate the effective rate of protection if ...

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