In Class We Discussed The Effect Of A Tariff On A Small Open Economy However Som

Q: In class, we discussed the effect of a tariff on a small open economy. However, some countries (e.g. the US) consume so much of some goods that their domestic demand significantly affects the world price. In this question, we will show that under such circumstances a positive tariff may be optimal for a large country.

(a) For simplicity, suppose that a good is fully imported so that there are no domestic producersof it. On a diagram, draw the domestic demand curve and the foreign supply curve of the goodto this country and show the free trade equilibrium. Mark off the equilibrium price (p) and2 the equilibrium quantity of the good. Shade the amount of consumer and producer surpluses generated by the equilibrium.

(b) Now draw another diagram which displays a tariff at rate t on the good. Show the new equilibrium price and quantity. How does the sum of consumer surplus, producer surplus, and tariff revenue compare with the sum of producer and consumer surplus in part(a)?

(c) Expand the diagram to include the epossibility of import subsidies (negative taco as in part (a), that the sum of consumer surplus, tariff revenues, and foreign producer surplus is maximized when the tariff is set equal to zero. Draw a diagram (with tariffs/subsidies on the

horizontal axis and the sum of surpluses on the vertical) that relates this total surplus to thetariff.(d) Show that, if the supply curve is upward sloping, foreign producer surplus consistently increases as tariffs are lowered to zero and continues to increase with import subsidies. Draw this curve on the same diagram as in part (c).

(e) If the domestic governments objective is to maximize the sum of consumer surplus and tariff revenue, show that this will lead it to set a strictly positive tariff.

#2 :A plot of land is owned by a Landlord but worked by a Tenant. If the Tenant provides efforts  L he incurs a cost C(L), which increases at an increasing rate with L. The value of output from the plot is given by the production function y=g(L) + x with probability 0.5 and y= g(L)-x with probability 0.5, where g(L) increases at a decreasing rate with L, and x represents random variations in output due to climatic conditions. The variance of output is therefore x2. The Landlord is risk neutral,but the Tenant is risk averse with a coefficient of risk aversion given by r. The Landlord can monitor the output produced by the Tenant, but cannot observe or infer the amount of effort she exerts.

(a) Using the above information, write down the expected utility index of the two parties under(1) a wage contract, (2) a rental contract and (3) a sharecropping contract in which the tenant receives a share s of the output produced and the landlord get the rest [Hint: the cost of risk to the Tenant under a sharecropping contract in this example is r(sx)^2].

(b) In each of these contracts describe how the risk is allocated between to two parties. What about the incentives faced by the Tenant to exert effort ?

(c) With the aid of a diagram, explain how the theoretical constrained-efficient output share, s(and the associated effort level, L*), is determined in a share-cropping contract.

(d) Suppose a new crop variety is introduced which is less sensitive to climate variations, so that x; and hence the marginal cost of risk, declines. According to the above theory, how should this affect the optimal sharing rule ?

Question onea. The market demand curve for the imported commodity will shift to theright and the market supply is not changed thus the equilibrium quantitygoes up and the equilibrium price rises…

Prof. Angela


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