Question 2

20 marks (5+2+2+2+4+5)

A country named Lobbyland is a large economy. The country is trading in the world marketplace but not freely, as it has a tariff in place to protect the automobile industry. However, a consumers' organisation called CO, has been recently lobbying the government to eliminate the tariff on automobile imports. The government is considering CO's proposal for future implementation. You have been appointed by the government to analyse the potential welfare impact of the tariff removal, in case the government decided to accept CO's request.

To conduct this task please consider the following information:

• If Lobbyland was in autarky the domestic equilibrium price of a car would be $40.
• The specific tariff in place to protect the local automobile industry is $10 per car imported.
• Because Lobbyland is not fully open to free trade, local consumers currently pay $25 per car (this is world price plus the $10 tariff).
• The world price without the tariff would be $20, but because Lobbyland is a large economy, the implementation of the tariff affected the international prices of cars, reducing the current world price to a value below $20. Make sure you correctly calculate the world price (when the tariff is in place).
• Current domestic supply at price $25 is 150 cars, while the domestic demand is 600 cars.
• If the tariff was removed, the domestic supply of cars at free-trade price of $20 would be 100 cars, while the domestic demand would be 650 cars.

1. (5 marks) Draw a graph that represents the Lobbyland market of cars (price and quantity of cars on the vertical and horizontal axes, respectively). Assume that the supply and demand curves are linear and that they start at the vertical axis (at quantity equal zero). Clearly label all the curves you draw, and indicate the world price before and after tariff, the domestic price after tariff, and the respective quantities supplied and demanded at Lobbyland before and after tariff.

1. (2 marks) What is the impact of removing the tariff on producer surplus? Provide a numerical value corresponding to the loss or gain in surplus, and clearly label the area corresponding to the change in producer surplus in the graph drawn in point (a). Hint: to calculate the change in surplus in this and following questions, you need to identify the area of the change in surplus (with and without tariff), and calculate the value of that specific area.

1. (2 marks) What is the impact of removing the tariff on consumer surplus? Provide a numerical value corresponding to the loss or gain in surplus, and clearly label the area corresponding to the change in consumer surplus in the graph drawn in point (a).

1. (2 marks) What is the impact of removing the tariff on government revenue? Provide a numerical value corresponding to the loss or gain in revenue, and clearly label the area corresponding to the change in government revenue in the graph drawn in point a).

1. (4 marks) Is the country better off or worse off after the tariff is removed? Provide a numerical value corresponding to the loss or gain in overall welfare.

1. (5 marks) If Lobbyland was a small economy with no influence over international prices, would it be possible for the country to achieve an overall welfare result similar to the result you obtained in point (e), after removing the tariff? Briefly explain.