Seminar 8 – The Political Economy of Trade Policy (questions).

1. What is the median voter theorem? How does it relate to trade policies of countries?
2. A small country can import a good at a world price of 10 per unit. The domestic supply curve of the good
is
The demand curve is S = 20 + 10P; D = 400 - 5P
In addition, each unit of production yields a marginal social benefit of 10.
a. Calculate the total effect on welfare of a tariff of 5 per unit levied on imports.
b. Calculate the total effect of a production subsidy of 5 per unit. Assume that consumers have
preference towards domestically produced goods.
c. Why does the production subsidy produce a greater gain in welfare than the tariff?
3. Upon Poland’s entering the European Union, suppose it is discovered that the cost of automobile
production in Poland is €20,000 while it is €30,000 in Germany. Suppose the EU, which has a customs union,
has an X percent tariff on automobiles and the costs of production are equal to Y (valued in euros) in Japan.
Comment on whether the addition of Poland to the European Union would result in trade creation or trade
diversion under the following scenarios:
a. X = 50% and Y = €18,000
b. X = 100% and Y = €18,000
c. X = 100% and Y = €12,000
4. “There is no point in the United States complaining about trade policies in Japan and Europe. Each country
has a right to do whatever is in its own best interest. Instead of complaining about foreign trade policies, the
United States should let other countries go their own way and give up our own prejudices about free trade and
follow suit.” Discuss both the economics and the political economy of this viewpoint.
5. Free trade is a precise political choice, with arguments for and against it. One of them includes providing
incentives to companies to internationalize themselves and export to new countries, thus fostering learning
and innovation, which eventually benefits the whole economy and helps competitiveness. Discuss this
approach with examples.
6. The minister for labor of the small nation of Pembangunan is eager to encourage domestic production of
digital clocks. A small clock industry exists, but only a few producers can survive foreign competition
without government help. The minister argues that helping the industry would create jobs and skills that will
be carried over into other industries by workers trained in this one. He calls for a 10 percent tariff to take
advantage of these benefits. At the same cabinet meeting, the minister for industry argues for a 10 percent
subsidy to domestic clock production instead, stating that the same benefits to the nation can be achieved at
less social cost.
a. Show the following diagrammatically:
i. The effects of the tariff on domestic clock output and consumption.
ii. The beneficial side effects of the tariff described by the minister for labor.
iii. The net gains or losses for the nation as a whole.
iv. All the same effects for the case of the production subsidy.
v. The differences in the effects of the two alternatives on the government’s budget.
Which policy would appeal more to a deficit-conscious minister for finance?
b. Can you describe a policy that captures the benefits of worker training better than
either the 10 percent tariff or the 10 percent production subsidy?
7. Australia has only one firm that makes aircraft. Without assistance from the government, that firm has lost
most of its business to imports from the United States and Europe. Which of the following policies would be
most costly for the Australian nation, and which would be least costly?
Policy A: Paying the lone Australian firm a production subsidy per plane, without protecting it
against imports.
Policy B: Imposing a tariff equal to the production subsidy in policy A.
Policy C: Imposing an import quota that cuts imports just as much as policy B would.
8. A country currently has free trade in men’s t-shirts, and the country imports half of its total domestic
consumption. The government of the country has fully committed to the goal of reducing the quantity
imported of t-shirts by one-third. The government is considering either a subsidy to domestic production or a
tariff on imports to achieve its goal.
A friend who works in the foreign ministry knows that you are studying international economics, and she
asks you to write a report comparing and contrasting the two policy alternatives (production subsidy or tariff).
To make the report more authoritative, you are going to use at least one graph and one or more key concepts
that you just learned in this chapter. What will you write and show in your report?