(a) Use a normal downward sloping demand curve and an upward sloping supply curve to illustrate and explain the “deadweight loss” from the imposition of a tariff on the imported substitute for a domestically produced product.
(b) Use your diagram to compare the effect of the tariff with a policy of providing the same benefits to domestic producers by means of a taxpayer funded per unit subsidy.
To illustrate and explain the deadweight loss from a tariff imposition, follow these steps:
(a)
1. Draw a graph with the quantity on the x-axis and the price on the y-axis.
2. Start by sketching a downward sloping demand curve to represent the demand for the domestically produced product. This curve shows the quantity consumers are willing to purchase at different prices.
3. Then, draw an upward sloping supply curve to represent the supply of the domestically produced product. This curve shows the quantity producers are willing to produce at different prices.
4. Identify the intersection point of the demand and supply curves, which represents the equilibrium price and quantity of the domestically produced product without any trade restrictions (tariffs).
5. Now, introduce a vertical line representing the tariff, which increases the price consumers have to pay.
6. Visualize the impact of the tariff by shifting the supply curve upwards by the amount of the tariff. This reflects a reduction in imported substitutes for the domestically produced product.
7. Observe the new equilibrium point at the intersection of the new supply curve and the original demand curve. This new equilibrium price is higher than the original one, and the quantity has decreased.
8. The deadweight loss is depicted by the triangle between the original equilibrium point and the new equilibrium point. This triangle represents the loss in consumer and producer surplus due to the reduction in quantity traded.
(b)
To compare the effect of the tariff with a policy of providing the same benefits to domestic producers through a taxpayer-funded per unit subsidy, make the following adjustments to the diagram:
1. Start with the diagram from part (a), where the tariff is imposed, and there is a deadweight loss.
2. Instead of visualizing the tariff, modify the graph by introducing a horizontal line representing the per unit subsidy to domestic producers.
3. Shift the supply curve downward by the amount of the per unit subsidy. This adjustment indicates that producers receive a direct benefit (in the form of subsidy) for each unit they produce.
4. Observe the new equilibrium point at the intersection of the new supply curve and the original demand curve. The equilibrium price is lower than the original one, and the quantity has increased.
5. Compare the deadweight loss under the subsidy policy to the deadweight loss under the tariff policy. In this case, the deadweight loss is represented by a smaller triangle, indicating a reduction in the loss of consumer and producer surplus.
By comparing the two policies, you can analyze the trade-off between using tariffs or subsidies to support domestic producers. The exact comparison will depend on the specific conditions and assumptions of the market being analyzed.