Question

2. A small country’s protectionism can be summarized: The typical tariff rate is 50 percent, the (absolute value of the) price elasticity of demand for imports is 1, imports would be 20 percent of the country’s GDP with free trade, and the protected industries represent 15 percent of GDP. Using our triangle analysis, what is the approximate magnitude of the economic costs of the tariff protection, as a percentage of the country’s GDP? As a percentage of the gain of producer surplus in the protected sectors?

Answer 1

With a price elasticity of demand for imports of 1, the 50 percent tariff rate has resulted in a 50 percent reduction in imports. The net national loss of the tariff as a percentage of the country's GDP equals (½)•0.50•0.50•0.20, or 2.5 percent. The increase in producer surplus in the protected sectors, as percentage of GDP, is approximately the 50 percent increase in domestic price times the 15 percent share of these sectors in GDP, or 7.5 percent. In this manner, the net national shortfall from the tariff is around 33 percent of the addition to secured makers. For each dollar that domestic makers gain, the remainder of the general public loses $1.33