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Tariff Analysis in General Equilibrium

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Tariff Analysis in General Equilibrium
Chapter 9 takes a partial equilibrium approach to the analysis of trade policy. That is, it focuses on the effects of tariffs, quotas, and other policies in a single market without explicitly considering the consequences for other markets. This partial equilibrium approach usually is adequate, and it is much simpler than a full general equilibrium treatment that takes cross-market effects into account. Nonetheless, it is sometimes important to do the general equilibrium analysis. In Chapter 6 we presented a brief discussion of the effects of tariffs in general equilibrium. This appendix presents a more detailed analysis. The analysis proceeds in two stages. First, we analyze the effects of a tariff in a small country, one that cannot affect its terms of trade; then we analyze the case of a large country.

A Tariff in a Small Country
Imagine a country that produces and consumes two goods, manufactures and food. The country is small, unable to affect its terms of trade; we will assume that it exports manufactures and imports food. Thus the country sells its manufactures to the world market at a given world price P * and buys food at a given world price P * . M F Figure 1 illustrates the position of this country in the absence of a tariff. The economy produces at the point on its production possibility frontier that is tangent to a line with slope -P * >P * , indicated by Q 1. This line also defines the economy’s budget constraint, M F that is, all the consumption points it can afford. The economy chooses the point on the budget constraint that is tangent to the highest possible indifference curve; this point is shown as D 1.

Figure 1
Free Trade Equilibrium for a Small Country The country produces at the point on its production frontier that is tangent to a line whose slope equals…...

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