Chapter 10. Chapter 10

Work It Out
Chapter 10
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You must read each slide, and complete any questions on the slide, in sequence.

Consider a large country with export subsidies in place for agriculture. Suppose the country changes its policy and decides to cut its subsidies in half.

Question

a. Are there gains or losses to the large country, or is it ambiguous? What is the impact on domestic prices for agriculture and on the world price?

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Two graphs show the impact on domestic and the world prices for agriculture.
image1

Correct. There are ambiguous gains to the large exporting country. Not only the deadweight losses decrease but terms-of-trade losses due to the subsidy are also diminished. As shown in the graph, cutting subsidies in half will shift the export supply curve up to [MATH: X-\frac{1}{2}S ]() . The world price of agriculture increases from [MATH: P^* ]() to [MATH: {P^*}' ]() , and domestic prices for agriculture drop from [MATH: P^*+s ]() to [MATH: {P^*}'+\frac{1}{2}S ]() . So consumer surplus increases and the Home terms-of-trade improves, and deadweight losses decrease, as represented by the reduced area [MATH: -(b + d + e) ]() .
Incorrect. There are ambiguous gains to the large exporting country. Not only the deadweight losses decrease but terms-of-trade losses due to the subsidy are also diminished. As shown in the graph, cutting subsidies in half will shift the export supply curve up to [MATH: X-\frac{1}{2}S ]() . The world price of agriculture increases from [MATH: P^* ]() to [MATH: {P^*}' ]() , and domestic prices for agriculture drop from [MATH: P^*+s ]() to [MATH: {P^*}'+\frac{1}{2}S ]() . So consumer surplus increases and the Home terms-of-trade improves, and deadweight losses decrease, as represented by the reduced area [MATH: -(b + d + e) ]() .
Video transcript

Work It Out, Chapter 10, Question 1

(Transcript of audio with descriptions. Transcript includes narrator headings and description headings of the visual content)

(Speaker)
This problem will ask you to consider a large country with export subsidies in place for agriculture that changes its policy and decides to cut its subsidies in half. Are there gains or losses to the large country, or is the situation ambiguous? What is the impact on domestic prices for agriculture and on the world price?

(Description)
Two coordinate planes with the horizontal x-axis and the vertical y-axis are drawn. The left plane is labeled (a) Home Market. The horizontal axis is labeled as Quantity, with points, D subscript 2, D subscript 1, S subscript 1, and S subscript 2, indicated from left to right. The vertical axis is labeled as Home Price, with points, p star, p star prime, p superscript W, p star prime plus one half times s, and p prime plus s, indicated from bottom to top. A straight line sloping downward from the left upper corner to the right lower corner of the plot is drawn. It is labeled D. Another straight line sloping upwards from the left lower corner to the right upper corner of the plot is drawn. It is labeled S. Lines, S and D, intersect at point with the x-value located between points, D subscript 1 and S subscript 1, and with the y-value located between points, 0 and p star. There are dotted lines drawn from points, D subscript 2, D subscript 1, S subscript 1, and S subscript 2, on the horizontal axis, which are parallel to the vertical axis, as well as from points, p star, p star prime, p superscript W, p star prime plus one half times s, and p prime plus s, on the vertical axis, which are parallel to the horizontal axis. The area labeled a is a rectangle with the following vertices. The first vertex is point with coordinates, 0 and p superscript W. The second vertex is point with coordinates, 0 and p star plus s. The third vertex is point with coordinates, D subscript 2 and p star plus s. The fourth vertex is point with coordinates, D subscript 2 and p superscript W. The area labeled b is a triangle with the following vertices. The first vertex is point with coordinates, D subscript 2 and p star plus s. The second vertex is point with coordinates, D subscript 2 and p superscript W. The third vertex is point with coordinates, D subscript 1 and p superscript W. The area labeled c is a trapezoid with the following vertices. The first vertex is point with coordinates, S subscript 1 and p superscript W. The second vertex is point with coordinates, S subscript 2 and p star plus s. The third vertex is point with coordinates, D subscript 2 and p star plus s. The fourth vertex is point with coordinates, D subscript 1 and p superscript W. The area labeled d is a triangle with the following vertices. The first vertex is point with coordinates, S subscript 2 and p star plus s. The second vertex is point with coordinates, S subscript 1 and p superscript W. The third vertex is point with coordinates, S subscript 2 and p superscript W. The area labeled e is a rectangle with the following vertices. The first vertex is point with coordinates, S subscript 2 and p superscript W. The second vertex is point with coordinates, S subscript 2 and p star. The third vertex is point with coordinates, D subscript 2 and p star. The fourth vertex is point with coordinates, D subscript 2 and p superscript W. The right plane is labeled (b) World Market. The horizontal axis is labeled as Exports, with points, X subscript 1, X subscript 3, and X subscript 2, indicated from left to right. The vertical axis is labeled as World Price, with points, p star, p star prime, p superscript W, p star prime plus one half times s, and p prime plus s, indicated from bottom to top. A straight line sloping downward from the left upper corner to the right lower corner of the plot is drawn. It is labeled Foreign import demand, M star. Another straight line sloping upwards from the left lower corner to the right upper corner of the plot is drawn. It is labeled Home export supply, X. Two straight lines, parallel to the line X, sloping upwards from the left lower corner to the right upper corner of the plot is drawn. They are labeled, X minus half s, and X minus S, respectively. Line X minus half s lies above line X minus s, but below line X. Lines, X and M star, intersect at point with coordinates, X subscript 1 and p superscript W. Lines, X minus half s and M star, intersect at point with coordinates, X subscript 3 and p star prime. Lines, X minus s and M star, intersect at point with coordinates, X subscript 2 and p star. There are dotted lines drawn from points, X subscript 1, X subscript 3, and X subscript 2 on the horizontal axis, parallel to the vertical axis, as well as from points, p star, p star prime, p superscript W, p star prime plus one half times s, and p prime plus s, on the vertical axis, parallel to the horizontal axis. The area labeled b plus d is a triangle with the following vertices. Th first vertex is a point with coordinates, X subscript 1 and p superscript W. The second vertex is a point with coordinates, X subscript 2 and p star plus s. The third vertex is a point with coordinates, X subscript 2 and p superscript W. The area labeled e prime is a rectangle with the following vertices. The first vertex is a point with coordinates, 0 and p star. The second vertex is a point with coordinates, 0 and p superscript W. The third vertex is a point with coordinates, X subscript 2 and p superscript W. The fourth vertex is a point with coordinates, X subscript 2 and p star. The area labeled f is a triangle with the following vertices. The first vertex is a point with coordinates, X subscript 3 and p star prime. The second vertex is a point with coordinates, X subscript 2 and p star. The third vertex is a point with coordinates, X subscript 2 and p superscript W. A downward arrow labeled s is drawn on right part of the line, X minus half s.

(Speaker)
There are ambiguous gains to the large exporting country. Not only the deadweight losses decrease but terms-of-trade losses due to the subsidy are also diminished. As shown in the graph, cutting subsidies in half will shift the export supply curve up to X minus half s. The world price of agriculture increases from P star to P star prime, and domestic prices for agriculture drop from P star plus s to P star prime plus half s. So consumer surplus increases and the Home terms-of-trade improves, and deadweight losses decrease, as represented by the reduced area negative(b plus d plus e).

Question

b. Suppose a small food-importing country abroad responds to the lowered subsidies by lowering its tariffs on agriculture by the same amount. Are there gains or losses to the small country, or is it ambiguous?

dDKrF0mL2+/PYtQ2tpUuVjmkGF0yRv5TDK8OqfkRqWV/xUDLbWHlNnqWI/N/ddKCTUVtdyjhEk7h2AECbKQQX5f3+VY=for the small country.
Correct. The optimal tariff level for a small country is zero, so in this case by reducing its tariffs the small country reduces the deadweight losses associated with the tariffs. If a small food-importing country reduces its tariffs by the same amount, then the Home supply curve will shift out to [MATH: X-s ]() and the world price will decrease to [MATH: P^* ]() , increasing the consumer surplus.
Incorrect. The optimal tariff level for a small country is zero, so in this case by reducing its tariffs the small country reduces the deadweight losses associated with the tariffs. If a small food-importing country reduces its tariffs by the same amount, then the Home supply curve will shift out to [MATH: X-s ]() and the world price will decrease to [MATH: P^* ]() , increasing the consumer surplus.
Video transcript

Work It Out, Chapter 10, Question 2

(Transcript of audio with descriptions. Transcript includes narrator headings and description headings of the visual content)

(Speaker)
This problem now will ask you to suppose that a small food-importing country abroad responds to the lowered subsidies by lowering its tariffs on agriculture by the same amount. Are there gains or losses to the small country, or is the situation ambiguous? Explain.

(Description)
The graphs from question 1 are shown.

(Speaker)
The optimal tariff level for a small country is zero, so in this case, by reducing its tariffs, the small country reduces the deadweight losses associated with the tariffs. If a small food-importing country reduces its tariffs by the same amount, then the Home supply curve will shift out to X minus s, and the world price will decrease to P star, increasing the consumer surplus.

Question

c. Suppose a large food-importing country abroad reciprocates by lowering its tariffs on agricultural goods by the same amount. Are there gains or losses to this large country, or is it ambiguous?

dDKrF0mL2+/PYtQ2tpUuVjmkGF0yRv5TDK8OqfkRqWV/xUDLbWHlNnqWI/N/ddKCTUVtdyjhEk7h2AECbKQQX5f3+VY=for the large country.
Correct. For a large country, the optimal tariff is positive, because (for small tariffs) terms-of-trade gains exceed deadweight losses. If we assume that the tariff-reducing country was previously at its optimal tariff, then welfare is reduced by cutting the tariff, but there is still an overall gain from the bilateral reduction in subsidies and tariffs. Because terms-of-trade gains for one party are terms-of-trade losses for the other, the net overall benefits of bilateral trade barrier removal are the reduction in both countries deadweight losses.
Incorrect. For a large country, the optimal tariff is positive, because (for small tariffs) terms-of-trade gains exceed deadweight losses. If we assume that the tariff-reducing country was previously at its optimal tariff, then welfare is reduced by cutting the tariff, but there is still an overall gain from the bilateral reduction in subsidies and tariffs. Because terms-of-trade gains for one party are terms-of-trade losses for the other, the net overall benefits of bilateral trade barrier removal are the reduction in both countries deadweight losses.
Video transcript

Work It Out, Chapter 10, Question 3

(Transcript of audio with descriptions. Transcript includes narrator headings and description headings of the visual content)

(Speaker)
This problem now will ask you to suppose that a large food-importing country abroad reciprocates by lowering its tariffs on agricultural goods by the same amount. Are there gains or losses to this large country, or is the situation ambiguous? Explain.

(Description)
The following text is written: (-) cutting tariff. (+) reduction in deadweight losses.

(Speaker)
For a large country, the optimal tariff is positive because (for small tariffs) terms-of-trade gains exceed deadweight losses. If we assume that the tariff-reducing country was previously at its optimal tariff, then welfare is reduced by cutting the tariff, but there is still an overall gain from the bilateral reduction in subsidies and tariffs. Because terms-of-trade gains for one party are terms-of-trade losses for the other, the net overall benefits of bilateral trade barrier removal are the reduction in both countries’ deadweight losses.