Question

Suppose a large country imposes a tariff on a product and the result of this are as follows:

The inefficiency loss from over production is $10 million. The inefficiency loss from under consumption is $5 million. The tariff revenue is $20 million.

Explain clearly the welfare impact of this policy on the large country.

Answer 1

When tariff is imposed, domestic price increases compared to free-trade price. At this higher domestic price, producers increase output, which increases their producer surplus. This increase equals $10 million. At the higher price, consumers decrease quantity demanded, which lowers their consumer surplus. This decrease in consumer surplus equals $5 million. Finally, tariff revenue equals $20 million which is collected by government.

Net welfare effect = Increase in producer surplus + Increase in tariff revenue - Decrease in consumer surplus

= $(10 + 20 - 5) Million

= $25 million

The net welfare effect is positive.