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IAI Actuarial Core Principles · Business Economics · Globalisation and multinational business

India imposes a specific tariff of Rs 200 on each imported unit of a good whose world price is Rs 1,000. Which of the following best describes the immediate effect on the domestic market, assuming India is a small importer?

A tariff of Rs 200 on a small importer lifts the domestic price to Rs 1,200. Domestic producers expand output, consumers buy less, and imports shrink. The world price remains Rs 1,000 because a small country cannot influence it.

  1. ADomestic price rises to Rs 1,200, domestic output rises and imports fallCorrect
  2. BDomestic price stays at Rs 1,000 because the world price is fixed
  3. CDomestic price rises to Rs 1,200 and domestic output falls
  4. DDomestic price falls to Rs 800 and imports rise
  5. Domestic price rises by less than Rs 200 because foreign exporters absorb the whole tariff

Explanation

For a small country the world price is unaffected by its tariff, so the domestic price rises by the full tariff to Rs 1,200. Higher prices encourage domestic producers to supply more and reduce domestic quantity demanded, so imports fall. Options claiming output falls or the price is unchanged ignore the tariff wedge.

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