Suppose that Japanese cars and American cars are identical from the viewpoint of their owners, but that Japanese cars cause harmful pollution while American cars do not. Each American owner of a Japanese car imposes $1,000 worth of pollution costs on his neighbors. Suppose that the U.S. supply and demand curves for cars cross at a price of $10,000, but Americans can buy as many cars as they want to from Japan at $7,000 apiece.
a. Draw a diagram to illustrate the social gain from the market for cars. Be sure to show gains and losses to all relevant groups of Americans.
b. Now suppose that the government imposes a tariff of $1,000 on all Japanese cars sold in the United States. Once again illustrate the social gain, making sure to include all relevant groups of Americans.
c. Does the tariff increase or decrease social welfare? By how much?