## In this question, we want to consider how different trade policies affect the national welfare

Question 1: In this question, we want to consider how different trade policies affect the national welfare. To do this, consider two identical countries: Country A and country B. (These countries do not trade with each other. Country A represents one type of trade policy and country B represents a different type of trade policy.)

The demand and supply for a good are shown below. Countries A and B both face a world price P_0^Wand each is using a trade policy so the domestic policy in each country is P_0^D with S0 = quantity supplied and D0 = quantity supplied.

The countries differ in that country A uses a specific tariff while country B uses a quota, with the import rights of the quota given away free to foreigners. The Excel spreadsheet used to create these figures is given along with this Word document. You can use the Excel charts or create your own charts. Simply take a picture and paste into this document.

What happens to welfare (consumers, producers, government) in these two countries when they impose a tariff (country A) or a quota (Country B)? How do your answers differ? Explain the difference.
Now, suppose that, for both countries, the world price of the good falls from P_0^W to P_1^W, and that each country keeps its particular trade policy (tariff or quota) in place at the same size as before. Show in the two figures above what happens to the domestic price, P_1^D, supply S1, and demand D1 after the world price changes.
How does the welfare in each country change after the world price falls? Describe in words and show in the figures the changes to consumers, producers, and the government.
How would any of your answers to parts (b) and (c) have been different if the tariff in country A had been ad valorem rather than specific?
How would any of your answers to parts (b) and (c) have been different if the quota in country B had been auctioned off by the government (and re-auctioned after the world price falls?

Question 2: This figure shows domestic supply and demand for a good in a small country, together with several prices and quantities labeled on the axes. Initially, with free trade, the country faces a world price equal to P1. Using the prices and quantities, as well as the areas labeled in the figure as appropriate, answer the following questions.

What is the quantity of imports with free trade at the world price P1?
Suppose the country now limits imports with a quota that raises domestic price to P3 (ignore P2 for now). What is the size of the quota? how much are the quota rents? and what size ad valorem tariff, t, would have done the same thing?
How much do domestic suppliers gain or lose (compared to free trade) as a result of this quota?
Suppose now the world price rises from P1 to P2. What are the effects of this rise in the world price in the presence of this (unchanged) quota?
The tariff equivalent (t)
Domestic suppliers
Domestic consumers
Suppose instead that the world price remains at P1 and that the quota itself is changed so that the domestic price falls to P2. If the rights to import are given away to foreigners, before and after this change, in what direction and by how much does the country’s net welfare change as a result of this change?

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