Question

Suppose the world price of kiwi fruit is \(\$ 25\) per case and the U.S. equilibrium price with no international trade is \(\$ 40\) per case. If the U.S. government had previously banned the import of kiwi fruit but then imposed a tariff of \(\$ 5\) per case and allowed kiwi imports, what would happen to the equilibrium price and quantity of kiwi fruit consumed in the United States?

Short answer

Answer: The \$5 tariff on imported kiwi fruit results in a decrease of the equilibrium price to \$30 per case and an increase in the equilibrium quantity (Q_t) in the United States market.

Step-by-step solution

Identify the initial equilibrium price and quantity in the United States

The given information states that with no international trade, the equilibrium price in the United States is \(\$ 40\) per case. This is the point where supply equals demand in the domestic market. Let's call the equilibrium price \(P_e\) and the equilibrium quantity \(Q_e\).

Identify the world price of kiwi fruit

The given information states that the world price of kiwi fruit is \(\$ 25\) per case. With international trade, this would be the price at which the United States could import kiwi. Let's denote this as \(P_w\).

Determine the new equilibrium price with the imposed tariff

With the tariff of \(\$ 5\) per case, the effective price at which kiwi fruit can be imported into the United States is now \(\$ 25 + \$ 5 = \$ 30\) (=\(P_w +\) tariff) per case. Since the domestic price in the United States is \(\$ 40\), the new price with the imposed tariff is less expensive than the original domestic price. This will lead to increased demand for imported kiwi fruit and result in a new equilibrium price. Let's call this new equilibrium price \(P_t\).

Compare the new equilibrium price to the initial equilibrium price

As the new equilibrium price of \(P_t = \$ 30\) is less than the initial equilibrium price of \(P_e = \$ 40\), the equilibrium price in the United States will decrease.

Determine the new equilibrium quantity

As the equilibrium price decreases to the new level of \(P_t = \$ 30\), the quantity demanded will increase. This is because lower prices generally lead to an increase in demand for a product. Moreover, the equilibrium quantity will also increase due to the availability of the imported kiwi fruit. Let's denote the new equilibrium quantity as \(Q_t\).

Summarize

After imposing a tariff of \(\$ 5\) per case on imported kiwi fruits, the equilibrium price in the United States will decrease to \(\$ 30\) per case, and the equilibrium quantity will increase to \(Q_t\).

Key concepts

Equilibrium Price

The concept of equilibrium price is pivotal in understanding both domestic and international trade dynamics. In economics, the equilibrium price is the point where the quantity of a product supplied by producers equals the quantity demanded by consumers. This is where the supply and demand curves intersect.

For example, consider the case of kiwi fruit in the U.S. market. Initially, without the influence of international trade, the equilibrium price was established at $40 per case. This means that at $40, the amount of kiwi farmers were willing to supply equaled the amount consumers were willing to buy.

• Equilibrium ensures market stability.
• At this price, there's no surplus or shortage in the market.
• It reflects a balance between producers' costs and consumers' willingness to pay.

Factors like government policies, market trends, and changes in global prices can shift this equilibrium. As seen in this scenario, introducing an international market price can significantly alter the domestic equilibrium.

Tariff

A tariff is a form of trade barrier whereby a country imposes a tax on imports, raising their price and reducing the competitiveness of foreign goods. Governments use tariffs to protect domestic industries from international competition by increasing the cost of imported goods.

In our kiwi fruit case, a $5 tariff was imposed on each case of kiwi entering the U.S. market. This raised the previously cheaper world price of $25 to $30 per case for consumers.

• Tariffs make imported goods more expensive.
• They provide domestic industries a buffer by narrowing the price gap between local and foreign goods.
• However, they can lead to higher prices for consumers if the costs are passed on.

Despite the increased price from tariffs, the imported kiwi remained cheaper than the initial domestic price of $40, thus still encouraging importation.

Supply and Demand

Supply and demand are the fundamental forces shaping the market economy. Supply refers to the amount of a good that producers are willing and able to sell at a given price, while demand refers to the amount that consumers are willing and able to purchase.

In the context of the exercise, the domestic supply and demand for kiwi fruits initially balanced at an equilibrium price of $40 per case. However, when the world market price was introduced and then adjusted by the tariff, the dynamics changed significantly.

• As prices fall due to cheaper imports, demand tends to increase.
• More kiwis are imported, leading to a new, lower equilibrium price of $30.
• Increased supply from imports often affects domestic producers, who must adjust prices to remain competitive.

Understanding supply and demand helps predict how various factors, like tariffs, influence market behaviors and determine the new equilibrium in a changing economic landscape.