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426 CHAPTER 10 COMPETITIVE MARKETS: APPLICATIONS

$20

Price (dollars per unit) A Domestic supply

$8
B
P + $2 tariff = $6 C E
w
F H J
G K
P = $4
w
L
$2
Domestic demand
Q = 2 Q = 4 Q = 6 Q = 8 10
1 2 3 5
Q = 7
4
Quantity (millions of units per year)
Free Trade
(with no tariff) With Tariff Impact of Tariff

Consumer surplus (domestic) A + B + C+E+F+ A + B + C+E –F – G – H – J – K
G + H + J+K
Producer surplus (domestic) L F + L F

Impact on government budget zero H + J H + J

Net benefits (domestic) A + B + C + E + F + A + B + C + E + –G – H – J – K
(consumer surplus + domestic G + H + J + K + L F + L
producer surplus + impact on
government budget)
Deadweight loss zero G + K G + K

Producer surplus (foreign) zero zero zero

FIGURE 10.16 Impact of a Tariff of $2 per Unit versus Free Trade
With free trade, the good would sell at the world price P w $4 per unit, with 2 million units
supplied domestically and 6 million units imported, for a total quantity of Q 5 8 million
units per year. By imposing a tariff of $2 per unit, the government could support a price of
$6 per unit, with 4 million units supplied domestically and 3 million units imported, for a
total quantity of Q 4 7 million units per year. Compared with free trade, a tariff has much
the same impact as a quota (see Figure 10.15), but rather than generating a producer surplus
for foreign suppliers, it generates revenues for the government, which the government can
use to benefit the domestic economy.