8/13/2019 Trade_War http://slidepdf.com/reader/full/tradewar 1/12 Tariff level in Home (use the spinner to control). Equilibrium prices and quantities in Home with the tariff in place. Equilibrium prices and quantities in Home with free trade. Equilibrium prices and quantities in Home in autarky. Welfare levels for Home in autarky. Welfare levels for Home with free trade. Welfare levels for Hom with tariff in place. Difference in surplus for Domestic demand and supply in Home (the importing country). Excess deman supply (the market). Parameters of Home's domestic demand. Parameters of Home's domestic supply. Difference in surp Home relative to trade (gain/loss intervention
the spinner next to cell D31), the world price falls and total surplus rises. In effect, Home exploits its monopsony
power to extract a lower price from Foreign. But this process cannot continue forever, Home is still limited by
Foreign's willingness to supply. As you increase the tariff, keep a close eye on total surplus in Home. Eventually
its rate of increase will slow, and then it will fall. When you find the tariff that maximizes total surplus, you have
determined the 'optimal' tariff. Points to note: 1) Tariff revenue will still be increasing at the optimal tariff. Can
you find the revenue maximizing tariff? It must be larger than the optimal tariff. 2) The optimal tariff depends on
the elasticity of foreign supply. Try decreasing the slope of the Foreign supply curve (cell P30). What happens to
the optimal tariff of Home? You should find that the optimal tariff is smaller. The reason is that the elasticity of
Foreign supply is decreased, giving Home less market power to exploit. 3) There is an optimal export tax too,
2. Trade Wars and Retaliation
other, taking the intervention imposed by the other country as given. Start by finding the optimal tariff forHome. Now find the optimal Foreign response, leaving the original intervention in place. Since welfare increases,
it is in Foreign's interest to respond to the original tariff. Once Foreign does respond, what is the best option for
Home? Perhaps surprisingly, it is in Home's best interest to lower its original tariff. After a few rounds, we reach
a point where neither country can move without lowering total surplus. This is a Nash equilibrium. Points to
note: 1) Total surplus is lower for both countries at the end of the war relative to free trade. For some
configurations of demand and supply it is possible that one country may be better off, but not both. 2) The
3. Countervailing Export Subsidies
Foreign (a negative value in cell M31). What are the consequences? For Foreign the export subsidy forces the
world price down, in addition to introducing a deadweight loss. Home on the other hand experiences a net
welfare gain from its improved terms of trade. How should Home respond? From a net welfare perspective they
should do nothing, but domestic producers are hurt. Under WTO rules, Home can apply a countervailing duty
equal to the value of the export subsidy. To simulate this put a tariff of the same magnitude as the export
subsidy (it will be a positive value) in cell D31. What is the net result? The free trade world prices are restored -
