model answer traiff and j curve

Question 1

j curve

Answer 1

Initially the economy has a current account deficit, where the value of imports exceeds the value of exports, plus net primary and secondary income. Due to a depreciation of the currency at point A, exports become cheaper and imports become more expensive. In the short term, the demand for imports and exports is relatively inelastic and thus the Marshall Lerner Condition is not met. This may be due to companies having inflexible contracts with suppliers or customers. As a result, export revenue falls and import expenditure rises, worsening the current account deficit, as shown from point A to B. Over time, export and import demand become more elastic as contracts run out and firms switch to cheaper suppliers; as a result, export revenue increases and import expenditure falls, improving the current account deficit after point B. The Marshall Lerner Condition is met where PEDx + PEDm ≥ 1 at point B.

Question 2

tariff digram

Answer 2

Under the conditions of free trade, the market for steel is initially in equilibrium where Q4 steel is bought and sold at price Pw. Q1 quantity of steel is supplied by domestic producers and Q4 – Q1 quantity of steel is produced by foreign producers. A tariff is an indirect specific tax on imported goods and services, which shifts S(world) up to S(world) + tariff. The market is now in equilibrium where Q3 steel is bought and sold at a higher price of Pw+t. Domestic producers benefit as they now produce the higher quantity Q3 of steel and receive the higher price Pw+t. Domestic producer surplus rises by the area A. Foreign producers are negatively impacted as they now sell the lower quantity Q3-Q2 of steel at the same price Pw. Consumers are negatively affected as they now pay a higher price and buy a lower quantity of the good, losing [ABCD] of consumer surplus; in the case of steel this is likely to affect all manner of goods in which steel is a factor of production. The government gains C of tariff revenue, while B and D are deadweight welfare loss as a result of inefficient domestic production and a smaller market size.