1 Problem solving: NAFTA (40 points) Assume the following: ·The world has many c
ID: 1138112 • Letter: 1
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1 Problem solving: NAFTA (40 points) Assume the following: ·The world has many countries The US imports all of its tomatoes (T) from Mexico and Mexico imports all of its cars (C) from the US Initially, becaase of NAFTA, there is free trade in cars and tomatoes between the US and Mexico But,Donald Trump takes the US out of NAFTA 1. Impact on the US due to the US tariff increase on tomatoes associated with backing out of NAFTA (a) Analyae the welfare efects of ths policy Sor the US (ie. the change is COnSuer surplus, producer surplus and goverament revenue) under the assumption that the US is a large impoeting country on the world market for tomatoes. Explain whether the US could benefit from such a policy (b) Analyze the welfare effects of this policy for the US under the assumption that the US is a small importing country on the world market for tomatoes. Explain whether the US could benefit from such a policy 2. Impact on the US due to the higher Mexican tariff on cars associated with dissolution of NAFTA (Note: we did not do this in class, so the aim here is to get you to apply the concepts ahove to a slightly different setting) (a) Analyze the welfare effects of this policy for the US under the assumption that Mexico is a large importing country on the world market for cars. Explain whether the US could benelit from this tariff increase. (b) Analyze the welfare effects of this policy for the US under the assumption that Mexico is a small importing country on the world market for cars. Explain whether the US could benelit from this tariff increaseExplanation / Answer
1. (a) When tariffs are imposed, tomatoes will be more expensive and this will translate into decline in consumer surplus.
Further, information provided states that "US imports all of its tomatoes" and therefore there is no local production. This elimiates the case for lower of higher producer surplus. However, had there been local production, the local producers would have benefitted as their production would have been price competitive (no tariffs) and the producer surplus would have increased.
Since the assumption is that US is a large importing country on the world market for tomatoes, any tariff would have a significantly positive impact on US government revenue. The US government revenue will increase meaningfully.
Overall, the decline in consumer surplus is a negative factor. However, since US is a major importer, I believe that the benefit of increase in government revenue more than offsets the decline in consumer surplus (if we look at it from the broad economic perspective). Therefore, the policy is positive for the US. Also, considering the fact that US has sustained trade deficit and increase in government debt, any increase in government revenue is a positive.
1. (b) If US if a small importing country, the impact on government revenue from tariffs will not be significant. On the other hand, consumer surplus will be impacted negatively on tariff imposition. In this scenario, the net benefit for the US is negative as consumer surplus declines and this will impact savings or consumption on other goods & services. The benefit of tariff on government revenue will be less and it would not make sense to impose tariff in such a scenario.
2 (a) The key point here is that Mexico is a large importing country on the world market for cars. If Mexico imposes tariffs on cars, the immediate impact will be that price of cars (imported from US) in Mexico will increase significantly. The result will be aa sharp decline in demand for cars that are imported from the US. This will result in decline in revenue for the automobile companies in the United States. In turn, the taxes from the automobile sector will also decline and this impacts US government revenue as well. So the negative impact is on the US corporate sector as well as the government sector and US will not benefit from this tariff.
(b) Since Mexico is a small importing country on the world market for cars, Mexican tariffs would impact import of US cars to Mexico. However, Mexico being a small importer, the negative impact is likely to be limited for US car manufacturers and the government. The US car manufacturers will shift focus to imports in countries where there are no (or relatively less) tariffs and this will offset any potential decline in revenue from Mexican tariffs. The benefit to the US from this tariff increase would largely depend on the focus shift of US car exporters to other major importing countries and the benefit derived from importing to those countries.
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