Suppose a domestically produced motor bicycle sells at a world price of $5000 under unrestricted trade. The domestic producer uses $3000 worth of imported inputs, (VA*). The $2000 difference between the world price of the final motor bicycle and the cost of the imported components represents domestic value added (VA). Domestic value-added includes the payments made to domestic labor and capital inputs. Under restricted trade, domestic value-added cannot exceed $2000, or the price of the domestically produced motor bicycle will exceed that of imported ones and the domestic ones will not sell. Suppose a 10 percent ad valorem (on the value) tariff is imposed on the imported motor bicycle.

i. What is the domestic price of the imported motor bicycle?

ii. What is the possible price of the domestically produced motor bicycle?

iii. What is the domestic value-added of the imported motor bicycle (VA*)?

iv. What is the effective rate of protection (ERP)?

v. Is this an effective rate of protection? Why or why not?

vi. What price do domestic producers pay on the imported components that they use as inputs?

vii. What is the amount of the new domestic value-added after the tariff? (Note: the new value-added is the difference between the tariffed price of imported motor bicycles and the tariffed price of imported inputs used in domestic production.)

viii. What is the value of the new ERP?

ix. Suppose that the government decided to tax the imported inputs by the same rate (10 percent) as the finished imported good. What is the ERP under this condition?