International Trade Assignment 3 Due Date November 24, 2015

International Trade Assignment 3due Date November 24 2015fall 2015

Attempt the following exercises. Exercise 1: You have been asked to quantify the welfare effects of the US sugar duty. The following table gives the estimates of the US consumption and production of sugar under the current duty and after the removal of the duty. Situation with import tariff Situation with zero import tariff Wold price of sugar $0.10 per pound $0.10 per pound Tariff (duty) $0.02 per pound 0 US consumption in billions of pounds per year 20 22 US production in billions of pounds per year 8 6 a) Estimate the consumer’s gain or loss from removing the tariff b) Estimate the producers gain or loss from removing the tariff c) Estimate the net effect of the US national well being d) Discuss the effect of the removal of the tariff on the income distribution in the US between the farm sector and the US relatively abundant factor of production e) Read case study 9-1 the effect of the US quota on sugar imports. Was it better to replace the tariff by a quota equal to billions of pounds of sugar? Exercise 2: Answer the following independent questions. Justify your answer a) How could there be an optimum tariff when most economists champion free trade? How can a country gain from imposing a tariff Are the economists dead wrong about free trade? b) Does the infant industry argument justify the imposition of tariffs on imports? Exercise 3: Answer the following independent questions. Justify your answer a) Why does the world trade organization urge its members to replace a quota by a tariff despite the fact that quotas like tariffs are harmful? b) Does the removal of a tariff cause a change in the income distribution of a country?

Paper For Above instruction

Introduction

International trade theories and policies have been at the forefront of economic discourse for centuries. The debate over tariffs, quotas, and free trade highlights the complex interplay between consumer welfare, producer interests, and overall national welfare. This paper delves into the specific case of the US sugar duty, exploring its welfare implications, the justification for tariffs from an economic standpoint, and the impact of policy shifts such as replacing quotas with tariffs. Additionally, the discussion extends to broader questions about the nature of trade policies, including the concept of an optimal tariff and the effective use of trade remedies aimed at protecting nascent industries.

Welfare Effects of the US Sugar Duty

The US implementation of a sugar import duty is a classic example of a protective tariff aimed at safeguarding domestic producers. Under the current duty of $0.02 per pound, the market maintains a world price of $0.10 per pound, resulting in specific trade and production patterns. When the duty is removed, the world price remains unchanged, but domestic consumption increases from 20 billion pounds to 22 billion pounds, while domestic production declines from 8 billion pounds to 6 billion pounds. These shifts indicate an increase in consumer surplus due to lower prices and increased consumption, but a reduction in producer surplus owing to decreased domestic production—highlighting a redistribution of welfare from producers to consumers.

Consumer Welfare

Consumers benefit from the removal of the tariff because the domestic price of sugar effectively falls to the world price of $0.10 per pound. The increase in consumption from 20 to 22 billion pounds suggests consumers are willing to buy more at the lower price, gaining consumer surplus. Quantifying this gain involves calculating the area of the triangle formed by the price reduction and the increase in quantity demanded, which reflects the net benefit to consumers.

Producer Welfare

Producers experience a loss because the reduction in domestic prices diminishes the value of their output, leading to a decrease in domestic production from 8 to 6 billion pounds. This decline in producer surplus translates into welfare loss, especially for domestic sugar farmers who face competition from cheaper imported sugar without the protective tariff.

Net Welfare Effect

The overall welfare effect depends on the magnitude of gains by consumers versus losses by producers. The net effect of removing the tariff can be positive if consumer gains outweigh producer losses, leading to an increase in national welfare. Empirical estimates suggest that in this scenario, the net welfare gain favors consumers, aligning with free trade principles that prioritize overall efficiency and consumer benefits.

Income Distribution Impacts

The removal of the tariff shifts income from the farm sector, which is relatively labor and land abundant, toward consumers across the country. This redistribution benefits the broader economy but may adversely affect specific rural or farming communities heavily dependent on sugar production. The income distribution effect underscores the political and social complexities inherent in trade policy decisions.

Case Study Analysis: US Quota vs. Tariff

The case study of US sugar quotas illustrates the differences between import quotas and tariffs. Replacing a tariff with a quota restricts import quantities directly, often leading to rent-seeking behaviors and inefficiencies. While quotas can be politically appealing, economists argue that tariffs are more transparent and less distortionary. The choice between them depends on trade policy objectives and administrative capacity.

Broader Questions

Optimum Tariff and Free Trade

Despite the dominance of free trade advocacy, the concept of an optimum tariff acknowledges that a country with market power can impose a tariff to improve its terms of trade. This strategy enables a nation to earn a welfare gain by raising domestic prices relative to world prices, thus capturing some of the gains from trade. However, many economists caution that such gains are limited and can provoke retaliatory measures, undermining global welfare.

Infant Industry Justification

The infant industry argument justifies tariffs as a temporary measure to protect developing sectors until they become competitive internationally. While this rationale can be beneficial, it often faces criticisms related to the risks of government failure and the difficulty of identifying truly viable industries deserving protection.

WTO and Quotas vs. Tariffs

The World Trade Organization advocates replacing quotas with tariffs because tariffs generate government revenue and are more transparent and easier to monitor. Quotas often lead to rent-seeking and corruption, while tariffs, although potentially harmful, are generally considered more consistent with transparent trade policies.

Income Distribution and Trade Policy Changes

Removing tariffs can alter income distribution within a country by shifting income away from protected industries toward consumers and other sectors. These changes can create winners and losers, necessitating complementary policies such as social safety nets or retraining programs to address adverse impacts on specific groups.

Conclusion

Trade policies like tariffs and quotas aim to balance domestic interests with economic efficiency. The case of the US sugar duty exemplifies the typical welfare impacts, highlighting gains for consumers and losses for producers upon tariff removal. Broader economic principles justify some tariffs under specific conditions, especially for nascent industries, but generally, free trade remains the optimal framework for maximizing global welfare. However, understanding the nuanced motivations behind tariffs, including strategic and political considerations, is essential for crafting effective and equitable trade policies.

References

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