Consider a world with two countries, H and F. H is the importer of a homogeneous good produced by perfectly competitive firms and F is the exporter (so both countries are “large”).
1. Draw 3 graphs, one for H and one for F and one for the world market, that illustrate the free trade equilibrium. Make sure that the graphs include quantities demanded and supplied at the free trade price. Make clear how much H imports and how much F exports.
2. Suppose that H imposes a tariff of size t on imports from F. Show on one graph how this tariff affects consumer surplus, producer surplus and government revenue in H. Draw the graph so that H is better off because of the tariff and make clear why this is so. Show on a separate graph, how the tariff affects welfare in F. Indicate how consumer surplus and producer surplus in F has changed
3. Now suppose instead that F puts a tax on its exports to H (for every unit sold abroad, the exporter has to pay a tax of T). How does the export tax affect the price paid by consumers and producers in H? Explain.
4. How does the F’s export tax affect welfare in F? Show using a diagram that makes clear what has happened to F’s exports, its consumer surplus, its producer surplus, and government revenue.