Example i: The welfare implications of a tariff in a Closed, Protected and Free Trade Economy	Syllabus Reference 4.2 Syllabus Reference 197-207 Grade weight = 4 Webnote 422 Source: Rees + Smith Economic Development pp 121-122

Type of economy:	Closed economy	Protected economy	Free Trade
Equilibrium P + Q	Pe q5	Pw +t, q4	Pw q2
Domestic consumer Surplus	Pe be	Pw+t b h	Pw b c
Domestic producer Surplus	A pe e	A pw+t g	A pw f
‘Green’ gain	none	gek	fel
Gain for society	none	keh	lec
Government revenue	none	jghi	none

Price B Domestic + international Market : Socks S (dom) Pe e World market: socks G k h pw+t d (world) Pw + T f c Pw j L I pw S(world) A D (dom) 0 q1 q3 q 5 q4 q2 Quantity

Note: ‘green gain’ refers to a better use of the resources in the World i.e. better resource allocation

Equilibrium P + Q
Domestic consumer Surplus
Domestic producer Surplus
‘Green’ gain
Gain for society
Government revenue

Task1: For each of the above (1-6) show the area for a closed economy.

Task2: For each of the above (1-6) show the area for a protected economy.

Task3: For each of the above (1-6) show the area for a free trade economy.

Task 4: Show how employment increases as a result of tariff protection.

Task 5: Show a ‘deadweight loss’ = loss to society, as a result of the tariff.

Webnote 422

Key:

Example ii: The welfare implications of a Free Trade Economy	Syllabus Reference 4.2 Syllabus Reference 197-207 Grade weight = 4 Sdom = supply in the domestic market without competition from imports

Ddom = domestic demand curve

Pe = Equilibrium in the domestic market without imports

PwSw = world supply curve at world price i.e. free trade

Dw = world demand curve

Sw = world supply curve in the world market

Points to Note:

World price ( Pw)is lower than Pdom / Pe on the assumption that the foreign producers are more efficient over some but not all of the domestic producers. This would most probably be an economies of scale problem for some domestic producers in an LDC

Horizontal supply curve in the domestic market as a result of the imports – see Pw Sw – suggests that the LDC is a ‘price taker’ and cannot produce quantities to influence the world price

The domestic producers face a serious threat as the world market can satisfy the entire domestic demand

Producer Surplus falls from APeE to APwF

Consumer Surplus rises from PeBE to PwBC

Wider selection of goods in domestic market and standard of living has improved because of the price fall and the selection of socks.

The end result is that Pw acts as a ceiling price and therefore efficiency is a must if domestic producers are to survive. Unemployment occurs in LDC as a result of loss of production /output q1 – q2.

FEG =CS due to transfer of production abroad. GEC = no win no loss area, socks are cheaper and Qd has increased