02 May Question: 2 Optimal tariff country A imposes a specific import tariff on good 1 country B is in free trade …
2 Optimal tariff country A imposes a specific import tariff on good 1 country B is in free trade two terms in the right-hand side of Eq. (4) . terms of trade effect: pi ↑ → UA ↓ (cf. Eq. (5) and Proposition 1 in Chapter 2) . distortionary effect: pitt’ -+z? –UA (cf. Eq. (13) and Proposition 7 in Chapter 2) 1-8A Proposition 1 A rise in an import tariff of a country always improves its terms of trade. intuition : T14 ↑ → ↓ → world excess supply of good 1 →Pi ↓ cf. Fig. 2 B dpi o Proposition 3 Starting from free trade, a rise in an import tariff of a country raises its welfare. welfare trade-off terms of trade effect: Pi-UAt distortionary effect: ㎡ ↑ → ↓ →UA ↓ for small ters of trade effect > Idistortionary effect (10): dUA Proposition 4 The optimal ad valorem import tariff of a country is equal to the inverse of the price elasticity of erport supply of the other country optimal tariff equilibrium is not Pareto efficient
1. Consider the model of optimal tariff in section 2: (a) Prove that Eqs. (1), (2), (3) imply that the market for good 2 clears. b) Derive Eqs.(7), (10), and (11 (c) Show that Pareto-improving reallocation from the optimal tariff equilibrium exists.
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