Question

Suppose the world price of butter is \(0.50 per pound and the domestic price in autarky is \)1.00 per pound. Use a diagram similar to Figure 5-10 to show the following.

a.If there is free trade, domestic butter producers want the government to impose a tariff of no less than\(0.50 per pound. Compare the outcome with a tariff of \)0.25 per pound.

b.What happens if a tariff greater than $0.50 per pound is imposed?

Short answer

a. A tariff of $0.50 per pound on butter will increase the price to $1.00 in the domestic market, which is the autarky price. There will be no demand for imports.

A tariff of $0.25 per pound on butter will increase the price level to $0.75, which is less than the autarky price. The amount of imports will be less than the free trade import size.

b. There will be no import if a tariff greater than $0.50 is imposed on the imported quantity of butter.

Step-by-step solution

Impact of tariff is no less than $0.50 and $0.25 per pound

The following depicts the domestic market of butter. The autarky price of $1.00 per pound lies at the equilibrium position, e. At this price level, the domestic quantity supplied is equal to the domestic quantity demanded. The world price of butter is $0.50, which is lower than the autarky price. Import is the gap between Q_S and Q_D.

• If the government decides to go with producers' demand and impose a tariff of $0.50 per pound on the imported quantity of butter, the price of butter in the domestic market will reach $0.1 per pound ($0.50 + 0.50). The price of $1.00 is also the autarky price for butter in the domestic market. The domestic quantity supplied is equal to the domestic quantity demanded at this price level. The gap between QD and QS will be zero. The import will reduce to zero.

• If the government decides to impose a tariff of $0.25 on the imported quantity of butter, then the price of butter will increase to $0.75 per pound. At this price level, the quantity supplied has increased to Q_s^T, and the quantity demanded has decreased to Q_D^T. It shows that the gap between the quantity demanded and quantity supplied has decreased. Thus, the imported quantity of butter will reduce.

Effect of a tariff greater than $0.50 per pound on butter.

At the autarky price level of $1.00, the domestic quantity supplied is equal to the domestic quantity demanded in the market. If the government decides to impose a tariff of more than $0.50 per pound, the imported price of butter will exceed the autarky price. No consumer will buy the imported good as the price is greater than the domestic price.

Hence, the importers will not import any quantity of butter in the market at any tariff equal to $0.50 per pound or above. Thus, the import will be blocked if the government imposes a tariff greater than $0.50 per pound.