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. The $2000 difference between the world price of the final motor bicycle and the cost of the imported components represents domestic value added. Domestic value added includes the payments made to domestic labor and capital inputs.Under unrestricted trade, domestic value-added cannot exceed $2000, else the price of domestically produced motor bicycle will exceed that of imported ones and the domestic ones will not sell. Suppose a 10% tariff rate 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 domestically produced motor bicycle?

(iii) What is the domestic value-added of the motor bicycle after the tariff?

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

Suppose now that the 10% tariff on finished motor bicycles is accompanied by a 5% tariff on imported components used in the domestic production of motor bicycles. (Answer the following two questions based on this proposition.)

(v) What price do domestic producers pay on the imported components that they use as inputs?

(vi) What is the value of the new ERP? (vii) Suppose that the government decided to tax the imported inputs by the same rate (10%) as the finished imported good. What is the ERP under this condition?