Question

Cotton Yarn and other fibers are imported inputs used to produce cloth in the United States (cloth is the finished product).

With free trade and no tariffs on either cloth or inputs, the price of one unit of cloth is $1. To produce one unit of cloth, $0.6 must be spent on cotton yarn and other fibers. Table I shows the division of values in one unit of cloth.

Table I: Free Trade: No Tariffs on Either Cloth or Inputs.

Cloth	Cost
Cotton Yarn (Input 1)	$0.3
Other Fibers (Input 2)	$0.3
Value Added	$0.4
Price of Cloth (One Unit)	$1

Suppose that the government imposes a 25% ad valorem tariff on cloth imports, and that a 16.7% tariff is levied on cotton yarn imports. There is no tariff on imports of other fibers.

1. Fill in the blanks in Table II. Table II shows the division of values in one unit of cloth after the tariffs are imposed. (10 pts)

Table II: 25% Tariff on Cloth Imports & 16.7% Tariff on Cotton Yarn Imports.

Cloth	Cost
Cotton Yarn (Input 1)
Other Fibers (Input 2)
Value Added
Price of Cloth (One Unit)

2. (Based on the information in Table I and Table II) Calculate the effective rate of protection using the following formula. (10 pts)

where

• is the amount of domestic value added under free trade with no tariffs.
• is the amount of domestic value added after taking into account all tariffs, both on the final good and intermediate inputs.

Answer 1

Cloth	New Cost Table || data is calculated	Original Cost without taxes( Table 1 Data	Interest Levied
Cotton Yarn(input 1)	$0.3(1+.167)= $0.35	$0.3	16.7%
Other Fibers (Input 2)	$0.3	$0.3	0%
Value Added	$0.6=Price of cloth -(Cotton inp+Other fibers)	$0.4
Price of Cloth	1(1+.25)=$1.25	$1	25%

i.e : New Cost =Old cost(1+ Tax percentage levied)

Value addition always happened even when the taxes were not levied and also when taxes were levied.

We can see that by evaluating

Domestic Value Added = Price of Cloth - (Cloth Yarn Cost +Other Fibers Cost) which is not equals to 0 that states domestic was always added