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IAI Actuarial Core Principles · Business Economics · Importance of international trade

India imposes a tariff on imported steel, with the world price unchanged and India a small price-taker. Compared with free trade, which combination of effects is correct?

The domestic steel price rises, producers gain and consumers lose, and the consumer loss exceeds the producer gain plus tariff revenue. The remainder is a deadweight loss, so national welfare falls compared with free trade for a small price-taking country.

  1. ADomestic price rises, domestic producers gain, consumers lose, and there is a net deadweight loss to the economyCorrect
  2. BDomestic price falls, consumers gain, and producers lose
  3. CDomestic price is unchanged, and government revenue rises
  4. DDomestic price rises, and total welfare rises because tariff revenue exceeds consumer losses
  5. World price rises by the full amount of the tariff, so there is no deadweight loss

Explanation

For a small country, a tariff raises the domestic price by the tariff amount. Producer surplus rises and consumer surplus falls by more than the producer gain plus government revenue. The difference is the deadweight loss from over-production and under-consumption. Welfare therefore falls overall.

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