by Steven M. Suranovic

# The Economic Effects: An Example

Consider the market for blue jeans in a small importing country depicted in the adjoining diagram. Suppose a sudden increase in the world supply of jeans causes the world market price to fall from \$35 to \$30. The price decrease causes an increase in domestic demand from 9 to 10 million pairs of jeans, a decrease in domestic supply from 8 to 6 million pairs, and an increase in imports from 1 to 4 million.

Because of these market changes, suppose that the import-competing industry uses its trade union to organize a petition to the government for temporary protection. Let's imagine that the industry calls for a \$5 tariff so as to reverse the effects of the import surge. Note, this type of action is allowable to WTO member countries under the "Escape Clause" or "Safeguards Clause."

We can use the measures of producer surplus and consumer surplus to calculate the effects of a \$5 tariff. These effects are summarized in the following table. The dollar values are calculated from the respective areas on the graph. [ Click HERE to see more details on the effects of a tariff in a small country case.]

 Welfare Effects of an Import Tariff Area on Graph \$ Value Consumer Surplus - (a + b + c + d) - \$47.5 million Producer Surplus + a + \$35 million Govt. Revenue + c + \$5 million National Welfare - (b + d) - \$7.5 million

Notice that consumers lose more than the gains which accrue to the domestic producers and the government combined. This is why national welfare is shown to decrease by \$7.5 million.

In order to assess the political ramifications of this potential policy, we will make some additional assumptions. In most markets the number of individuals that make up the demand side of the market is much larger than the number of firms that make up the domestic import-competing industry. Suppose then that the consumers in this market are made up of millions of individual households, each of which purchases, at most, one pair of jeans. Suppose the domestic blue jeans industry is made up of 35 separate firms.

International Trade Theory and Policy - Chapter 105-3: Last Updated on 3/3/01