sisu 300 test 2

What does home being large in the world market imply?

That Foreign has a upward sloping export supply curve and the world price is determined by the intersection of Foreign’s export supply and Home’s import demand

What does tax incidence analysis examine?

Which side of the market pays the actual economic burden of a tax

Key takeaway message of tax incidence analysis

The economic burden of a sales tax is usually shared between buyers and sellers

General effects of a sales tax

Increases buyers’ price and reduces the sellers’ price; tax is the difference between these two prices

What does a perfectly elastic supply do to a tax?

The entire burden of the tax is paid by the buyers/demand side

Effects of tariffs on prices in a large country case

Collected from foreign suppliers which results in an upward shift of the export supply curve, causes exporters’ prices to drop (terms of trade effect), sellers’ prices falls because foreigners must pay the tariff at the border

What happens to consumer surplus in a large country case?

Falls by area between world price and home price from the price line to the domestic demand line

What happens to producer surplus in a large country case?

Rises by the area between world price and home price from the price line to the domestic supply line

Deadweight losses in the large country case?

Production deadweight loss (area “b”) through inefficient domestic production and consumption deadweight loss (area “d”) through buyers leaving the market

Government tariff revenue in a large country case?

Areas “c” and “e”, tariff x the new import volume, area c is a transfer from domestic consumers and area e is a transfer from foreign suppliers via a terms of trade effect

What is the net welfare gain for a large country case?

e-b-d, reduces overall world welfare

What is the optimal tariff for a small country?

Zero

Import quota

Quantitative restriction on foreign imports

Key difference between tariffs and quotas?

Quota rent replaces the tariff revenue

What happens if a quota is not binding?

If it is set above the free trade import level, it has noe ffect

What happens with a binding quota?

Raises the domestic price above the world price

What happens if a quota is set at 0?

Raises the domestic price to the autarky price

What are the welfare effects of a quota?

Same consumer surplus loss, producer surplus gain, and deadweight losses as tariffs, but also the quota rent in between the deadweight losses

What does quota rent represent?

Gain from selling the units of the good at the price which is above the world market price

Who gets the quota rent?

Depends on how the quota licenses are allocated: quota licenses allocated to home firms, rent seeking, quota auctions, and voluntary export restraints

Quota licenses allocated to home firms

Domestic firms can then import the good at the world price and sell the good locally at the higher domestic price, domestic firms earn the quota rent, net effect on home welfare is -(b+d)

Rent seeking

The prospect of receiving quota licenses will encourage domestic firms to engage in inefficient activities in order to obtain a license; the quota rent is “wasted”, net effect on home welfare is - (b+c+d)

Quota auctions

Government allocates the quota licenses in a well-organized, competitive auction, where the collected revenues from auctioning the licenses equals the quota rent, home government earns the quota rent, net welfare effect is -(b+d)

voluntary export restraints

exporting country government allocates the quota among its exporters; home government provides a concession to foreigners for a quantitative trade restriction, quota rent goes abroad, net welfare effect is -(b+c+d)

Abolition of the Multifibre agreement

Allowed high income economies to restrict textile and apparel products from developing economies, after the removal there was a drop in prices from countries selling to the US, quota rents were earned by foreigners and the welfare gain to the US was area b+c+d

What does the model predict about the abolition of a quota?

Should reduce prices and increase imports of textiles

US welfare gains from the removal of the textile quotas

Because the quota was administered as a voluntary export restraint,

the US gain from the removal of the quota is the area (b+c+d), US also saw larger price drops in low quality goods

Quality shifting effect of a quota

Firms have an incentive to shift their exports towards higher quality goods because of higher profit margins in higher quality products, poorer households in US can benefit more proportionally to removal of quotas

How can a situation of strategic interaction be analyzed?

Basic game-theoretical framework

Effects of an optimal tariff by the US on the EU

US experiences a net gain of e-(b+d) and EU experiences a welfare loss of e+f (terms of trade loss and loss from reduced EU export supply)

Payoffs under a trade war

If both governments set an optimal tariff, each country’s payoff is e-(b+d)-(e+f)=-(b+d+f)<0

Why is the Nash equilibrium relevant for International Affairs?

Intellectuals hoped for a new peaceful world order based on cooperation and the formation of a world government; Nash equilibrium concept has become a core framework for analyzing different types of strategic interactions

How is the Nash equilibrium found?

By finding the dominant strategy; if both players have a dominant strategy then that is the equilibrium outcome for the game

What led to the creation of the GATT/WTO?

Non-cooperative behavior leads to a tariff war where both countries are worse off than under free trade; Prisoner’s Dilemma is the theoretical justification for the establishment of the GATT/WTO as it provides a credible institutional commitment for avoiding a trade war

US trade policy pre Great Depression

US tariff rates were set by Congress, Congress acted unilaterally to take the foreign country’s tariff rates as fixed and chose tariffs as domestic politics, often under pressure from industry lobbyists to raise tariffs and protect domestic industries from foreign competition

Tariff Act of 1930

Raised tariffs to record levels to protect US jobs and farmers from foreign competition and adjusted purchasing power to productive capacity, triggered by the Great Depression

Effects of Smoot-Hawley Tariff Act

Difficult to disentangle the effects of act from the 1929 stock market crash, in the following 2 years US imports fell by over 40%, thought to have deepened the Great Depression

Reciprocal Trade Agreements Act of 1934

Marked a departure from protectionism in the history of US trade policy, recognized the interdependence of trade policies by the US and its trading partners, gave authority of tariff setting to the President, allowed American exporters to lobby for lower tariffs and counteract the lobbying for higher tariffs by import-competing industries

How did Trump use the International Emergency Economic Powers Act?

Used the IEEPA to justify his dramatic tariff impositions in April 2025 but was ruled as unlawful by the Supreme Court

Establishment of GATT and WTO

GATT was established in 1947 to mandate reduced trade barriers through multilateral negotiations, replaced by the WTO in 1995

What are key provisions of the GATT?

Most favoured-nation treatment, anti-dumping and countervailing duties, elimination of quantitative restrictions, subsidies, and emergency actions on imports of particular products

What is the most favored nation provision

Non-discrimination principle to treat each nation as your most favored nation

What happened during the Kennedy round of the GATT?

Absolved developing countries from granting reciprocity to developed countries, 35% average tariff reduction, adoption of the anti-dumping code for speedy and fair investigations with limits on the applications of anti-dumping measures

What happened during the Tokyo round of the GATT?

US president had 60% tariff reductions authority but required concessions on import quotas in textiles due to the Trade Act of 1974, strengthened the role of the international trade commission, unresolved issues regarding developing countries’ interests and dispute settlements

Trade and Tariff Act of 1984

Gave the US president authority to negotiate bilateral trade treaties, forced other countries to support a new GATT deal or be left out of the liberalization process

Uruguay GATT round

negotiations on services and trade related aspects of intellectual property rights, developing countries did not believe there was sufficient progress on the cutting of agricultural export subsidies by rich economies, creation of the WTO

Doha GATT round

Developing countries were frustrated with the lack of willingness by rich economies to liberalize the agricultural sector, some progress on trade facilitation and reduction of trade costs borders/customs

When did preferential trade agreements really start to emerge?

1990s

Free trade areas

Member countries within a free trade area agree to eliminate tariffs and other trade restrictions among themselves, each member country is allowed to set different external tariffs towards non-members, often have complex rules of origin

Customs union

A free trade area where members have eliminated tariffs among themselves and agreed to a common schedule of external tariffs towards non-members, members have given up their sovereignty to set their own trade policies towards non-members

Voluntary export restraints in the automobile industry

Resulted in a quota-induced price increase of automobiles and quality upgrading by Japanese automakers

Infant industry protection

Protects a young domestic industry temporarily from foreign competition, allows it to mature and develop, then lifts the protection with the hope that it will sustain foreign competition after the protection has been lifted, depends on the existence of some form of market failure which prevents the possibility of private financing of the infant by banks

Justifications for infant industry protection

Potential for learning by doing and cost reductions, potential for knowledge spillovers as benefits could be external while the costs are internal to the innovating infant

Why is the average cost curve U-shaped?

Because of diminishing returns, marginal costs are increasing and average cost will increase at higher quantities

Purpose of protective tariff for infant industry

Shields the infant until it grows up to a lower cost structure and can survive on its own

When is infant industry protection justified?

If in the future, the industry matures and the producer surplus outweighs the deadweight losses

Challenges of infant industry protection

Uncertainty if the infant will ever mature or create the external benefits hoped for, not clear why governments are in a better position than private investors to spot the infant’s potential