Question

Suppose that only two countries, the US and Japan, are involved in the international

trade of automobiles. The relevant supply and demand functions for the US and Japan

are:

DUS = 100 – 15PUS DJapan = 100 -10PJ

SUS = 5 PUS SJapan = 40 + 40PJ

Moreover, there is a transport cost of λ=1 per car traded.

1. Calculate the world price under free trade and the quantity traded at this price.

Determine the welfare gains from free trade in both countries. (Mark: 0.5)

2. Suppose that the US government imposes a tariff equal to t=1.4 per car traded.

Find, for both countries, the resulting welfare changes (the total as well as the

group-specific ones). (Mark: 1.0)

3. Assume that due to technical change, transport costs have been reduced by 35%,

while the tariff imposed by US authorities remains unchanged. Calculate, for both

countries, the effects of the reduction in transportation costs on prices and on

quantities supplied, demanded and imported (exported). Determine for both

countries, the resulting welfare changes (the total as well as the group-specific

ones). Compare your findings with those obtained for part 2. (Mark: 1.5)

(Hint: The term group-specific refers to the groups of economic agents (consumers,

producers, and taxpayers) who are potentially affected by the trade policy and/or the

technical change).

Answer 1

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