effect of removing the tariff

Question 1:

(a) Suppose that the government of Arcadia, a small country, is considering the
removal of a 20% tariff on denim jackets. Currently 100,000 jackets are imported per year, out of a total annual consumption of 200,000 jackets. The import cost (i.e. without the tariff applied) is $25 per jacket. At that price it is estimated that total consumption would increase to 250,000 jackets per year, of which 190,000 would be imported. Calculate the effect of removing the tariff on:
• consumer surplus
• producer surplus
• government revenue
• net national welfare

(b) Illustrate your answer by means of a diagram.

(c) How would you answer critics who complain that the proposed removal of the tariff will increase unemployment in the country?

(d) Suppose that the cloth and other accessories used in domestic denim jacket manufacture are imported. These inputs would cost $15 per jacket if imported duty-free, but in fact there is a tariff of 10% on these inputs. Calculate the effective rate of protection for the local denim jacket producers (assuming that the tariff of 20% on finished denim jackets remains in place). Comment briefly (about 3 sentences) on the result of your calculation.

(e) Suppose that the domestic denim jacket manufacturers put an alternative
proposal to government, whereby the10% tariff on the imported inputs would be removed but the 20% tariff on the finished jackets would remain. The manufacturers argue that this would allow them to remain in business while improving their efficiency. Calculate the effective rate of protection that the manufacturers would enjoy if their proposal was accepted, and then provide a brief critical analysis of the manufacturers' proposal.

Question 2:

(a) In the case described above, suppose that the government of Arcadia decided
to use a quota restriction on imports rather than a tariff to protect its local denim jacket producers. Use a diagram to illustrate the imposition of a quota restriction that would result in the same effect on prices and quantities as the 20% tariff (assume that the domestic shirt-producing industry is competitive). Calculate the amount of quota rent that would be generated in this case. Identify the different parties that might be able to capture the quota rent and explain the conditions that would need to be fulfilled in each case to enable them to do so. Calculate the effect on the overall welfare outcome for Arcadia in each case.

(b) Suppose that the government of Arcadia had imposed the quota restriction at
the level identified in 2(a) above. Suppose then that overseas producers are able to reduce their costs by reorganising their production processes, so that the world price of denim jackets falls to $20 per jacket. Arcadian producers do not however make corresponding improvements in their production processes, and their production costs remain unchanged, so that the quantity of denim jackets that they can profitably supply at any given price also remains unchanged. The Arcadian government also maintains its quota restriction unchanged at the level identified in (a) above. It is estimated that at a price of $20 per jacket, total purchases of jackets by Arcadian consumers would have totalled 300,000 units, of which 20,000 units would have been supplied by Arcadian producers. You are required to:

• Illustrate by means of a clearly labelled diagram the new situation in Arcadia's market resulting from the fall in the world price for denim jackets.
• For the new world price of $20 per jacket, calculate the effect of the quota on consumer and producer surplus, and the quota rent associated with the quota in this case.
• Calculate the effect on Arcadia's national economic welfare, both in the case where the quota rent is captured by Arcadian importers, and the case where it is captured by foreign suppliers of jackets.
• Comment on how these results differ from those that you derived on the basis of the world price of $25 per jacket.
• Calculate the effective rate of protection enjoyed by Arcadian producers, given the new world price of $20 per jacket, but assuming that the tariff of 10% on imported inputs remains unchanged, and that the duty free cost of these imported inputs also remains unchanged at $15 per jacket. (Remember that the quota has been chosen to have the same effect on the price of denim jackets in the Arcadian market as a tariff of 20% applied to a world price of $25 per jacket). Comment briefly on the result of your calculation.
• Calculate the price of denim jackets that would apply in the Arcadian domestic market following the fall in the world price to $20 per jacket, if the Arcadian government was applying a 20% tariff on imported jackets instead of the quota restriction (and kept this tariff unchanged following the fall in world price). Briefly comment (1 sentence) on how and why the domestic market price corresponding to the new world price in the tariff case differs from the price in the quota case. The briefly explain (about 3 sentences) how the welfare outcome (corresponding to the new world price) in the tariff case would differ from the outcome in the quota case (note that you are not asked to calculate the welfare change in the tariff case in order to answer this part of the question).