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Complete Tables 1, 2, 3, 4, and 5 by typing your

answers directly into the respective boxes. When you


are done, save the file and then email it to me at
yikking@isu.edu before 11:59pm on Tuesday, Nov 11,
2014.
There are questions throughout the explanation. You
do NOT need to address those questions marks. Just
complete Tables 1, 2, 3, 4, and 5.
Dont worry about the format. After typing in your
answers, a table might extend outside of the slide.
Dont worry about it.

We are going to do a complete cost benefit analysis of a

tariff on steel by the US government.


As explained in the last set of slides, we are going to
use a table to make sure that we have accounted for
everything.
We will complete a series of 5 tables.
The following is the basic information we need to
complete the tables.

Before
In the beginning the US does not have a tariff on steel.
Since there is no tariff, the US price of steel is the same

as the world price of steel.


Say the price of steel was $9 per pound.
At $9 per pound, US users of steel bought 120 pounds
of steel.
Where did these 120 pounds come from?
20 pounds were supplied by US producer of steel.
100 pounds were imported.

After
Now the US imposes a $5 per pound tax on imported

steel.
Because of the tariff, the US price of steel (inclusive of
the $5 tariff) is going to be different from the world
price of steel (exclusive of the tariff).

What will be the world price of steel (exclusive of the

tariff )? Will it remain at $9 per pound?


Potential pitfall number 6 reminds you not to assume
things to stay the same.
If the US is a large buyer of steel, it is unlikely that the
world price of steel will remain at $9?
Is it going to go up or go down?
It will go down. This is because the $5 tariff reduces the
demand for imported steel. When demand goes down,
price goes down. (Just like when we dont demand corded
phones, the price of corded phone drops.)
Assume that it goes down to $8.
So the new world price of steel is $8 exclusive of the tariff.

What will be the US price of steel inclusive of the

tariff?
It will be equal to the $8 world price of steel plus the $5
tariff.
So the US price of steel (inclusive of the tariff) will be
$13.

How much will US users of steel buy? Will they

continue to buy 120 pounds of steel?


No, US price of steel is now higher at $13 instead of $9.
When price is higher, people buy less.
So US users of steel will buy less.
Assume that US users will now buy 110 pounds at $13
per pound.
So US users will cut back on steel use by 10 pounds
(120 minus 110) due to the tariff.

So when there is a tariff, US users will buy 110 pounds of

steel?
Where do these 110 pounds come from?
Will US producers continue to supply 20 pounds?
No, US price is higher at $13 instead of at $9 so US
producers will supply more at the higher price.
Assume that US producers will now supply 50 pounds at
the higher price of $13 (compared to 20 pounds at the lower
price of $9).
The remaining 60 pounds (110 minus 50) will be imported.

The following table sums up all the


information we need.
Before
No tariff on steel

After
$5 per pound tariff on steel

US users bought 120 pounds

Now they buy 110 pounds. They buy 10


pounds less than before.

US producers supplied 20 pounds

Now they supply 50 pounds. They


supply 30 pounds more than before.

Import is 100 pounds (120 minus 20)

Import is 60 pounds (110 minus 50)

World price of steel was $9

World price of steel is $8

US price of steel was $9

US price of steel (inclusive of tariff) is


$13

To avoid potential pitfall number 2, we will account for

all quantities by fully accounting for the 120 pounds


originally bought by US users before the tariff.

120 pounds bought by US users when there was no tariff

Table 1
20 pounds
supplied by US
producers
Table 2
Additional 30
pounds now
supplied by US
producers when
there is a tariff

100 pounds imported


when there was no tariff

Table 3
60 pounds
imported when
there is a tariff

Table 4
US users cut back
by 10 pounds
when there is a
tariff

Table 1
The 20 pounds of steel supplied by US producers both before and after the
tariff
Before

After

Gain
(after minus before)

Loss
(after minus before)

Net effect
(+ is net
gain; - is net
loss)

US producers

Sold at $9
per pound

Sold at $13
per pound

Revenue from 20
pounds of steel at
$13 per pound
minus revenue from
20 pounds of steel
at $9 per pound = ?

Cost of producing
20 pounds when
price is $13 minus
cost of producing
the same 20 pounds
when price is $9 = ?

US users

Bought at
$9 per
pound

Bought at
$13 per
pound

Value of 20 pounds
of steel to users
when price is $13
minus value of the
same 20 pounds of
steel when price is
$9 = ?

Payment for 20
pounds of steel at
$13 per pound
minus payment for
20 pounds of steel
at $9 per pound = ?

US govt

Not
involved

Not
involved

US as a whole

Table 2
The 30 pounds increase in production by US producers due to the tariff
Before

After

Gain
(after minus before)

Loss
(after minus before)

Net effect
(+ is net gain;
- is net loss)

US producers

Not
produced

Sold at $13 per


pound

Revenue from 30
pounds of steel at $13
per pound minus
revenue from zero
pounds of steel at $9
per pound = ?

Estimated cost of
producing 1 pound
of steel times 30
pounds = ?
See Box A
explanation.

US users

Bought at
$9 per
pound
from
abroad

Bought at $13
per pound from
US producers

Value of 30 pounds
of steel to users
when price is $13
minus value of the
same 30 pounds of
steel when price is $9
=?

Payment for 30
pounds of steel at $13
per pound minus
payment for 30
pounds of steel at $9
per pound = ?

US govt

Not
involved
because
there was
no tariff

Not involved
because these
30 pounds are
not imports

US as a
whole

Box A explanation
The loss in Box A is the cost of producing 30 pounds of

steel.
Do we know the cost of producing 30 pounds of steel?
We dont know the exact cost.
However, we can form a reasonable estimate based on
two observations.

Box A explanation continued


Observation 1:
US producers are producing and selling 30 pounds

more of steel when the price is higher at $13 after the


tariff.
Observation 2:
US producers were not producing and selling these 30
pounds of steel when the price was lower at $9 before
the tariff.

Box A explanation continued


Observation 1:
US producers are producing and selling 30 pounds

more of steel when the price is higher at $13 per pound


after the tariff.
What does this tell you about the maximum (average)
cost of producing 1 pound of steel?
The (average) cost is at most $13.

Box A explanation continued


Observation 2:
US producers were not producing and selling these 30

pounds of steel when the price was lower at $9 per


pound before the tariff.
What does this tell you about the minimum (average)
cost of producing 1 pound of steel?
The (average) cost is at least $9.

Box A explanation continued


So the maximum average cost is $13.
And the minimum average cost is $9.
A reasonable estimate of the average cost is the middle

between the maximum and the minimum.


Therefore ($? + $?) divided by 2 = $? is a reasonable
estimate of the average cost.
The total cost of producing 30 pounds is then $? times
30 = $?, which is in Box A.

Box B explanation
In Box B we see that the US as a whole has a loss of $?.
Here is an intuitive explanation of this loss.
Before the tariff, the US was paying $9 per pound to import

these 30 pounds of steel from abroad.


After the tariff, the US was producing these 30 pounds of
steel at home at an average cost of $?.
So the US is paying $? more per pound ($? minus $9).
$? more per pound times 30 pounds is $?.
This explanation is intuitive and is a short-cut.
There is still value in doing the long table. We are sure that
we have accounted for everything and that we have not left
anything out.

Box B explanation continued


The technical name for the $? loss in Box B is:
Change in producer surplus.
It is also called the deadweight loss due to production

distortion.
With a tariff, the US is over-producing steel by 30
pounds. Those 30 pounds should have been imported
at $9 per pounds instead of being produced at home at
$? per pounds. We call this over-production a
production distortion.

Box B explanation continued


The $? loss can also be calculated as the area of a (right-

angle) triangle.

Height is
$?
Base is
30 pounds

The base is the increase in US production of steel due to

the tariff.
The height is the increase in US price of steel due to the
tariff (from $9 to $13).
The area of this triangle is base times height divided by 2 =
30 times ? divided by 2 = ?
So the deadweight loss is also called a deadweight loss
triangle.

Table 3
The 60 pounds of steel imported by the US after the tariff
Before

After

Gain
(after minus before)

Loss
(after minus before)

Net effect
(+ is net
gain; - is net
loss)

US producers

Not
involved

Not
involved

US users

Bought at
$9 per
pound
from
abroad

Bought at
$13 per
pound
from
abroad

Value of 60 pounds
of steel to users
when price is $13
minus value of the
same 60 pounds of
steel when price is
$9 = ?

Payment for 60
pounds of steel at
$13 per pound
minus payment for
60 pounds of steel
at $9 per pound = ?

US govt

Not
involved
because
there was
no tariff

$5 per
pound
tariff

$5 per pound tariff


revenue times ?
pounds = $?
increase in tariff
revenue

US as a whole

Note that from Table 3, the US government collects $?

of tariff revenue.
However, these $? does not represent a net gain to the
US from the 60 pounds of steel import.
This is because US users pay $? more for these 60
pounds of steel than before the tariff.
So the net gain to the US from these 60 pounds is $?
($? gain to US government minus $? loss to US users).

Table 4
The 10 pounds decrease in purchase by US users of steel when price went
from $9 to $13 per pound due to the tariff
Before

After

Gain
(after minus before)

Loss
(after minus before)

Net effect
(+ is net
gain; - is net
loss)

US producers

Not
involved

Not
involved

US users

Bought at
$9 per
pound

Not bought
at $13 per
pound

Expenditure went
down by $9 per
pound. Total saving
is $9 time 10 = $?

Estimated value of 1
pound of steel times
10 pounds = ?
See Box C
explanation.

US govt

Not
involved
because
there was
no tariff

Not
involved
because
these 5
pounds are
no longer
imported

US as a whole

?
See Box D
explanation.

Box C explanation
US users of steel cut back on their purchase of steel by

10 pounds when the price went up from $9 to $13 due to


the tariff.
When they do not buy these 10 pounds, users lose the
value that could be obtained from steel. For example,
the user could have used the steel to build a ship and
sell the ship for a profit.
How much value do users lose?
We dont know the exact value.
However, we can form a reasonable estimate based on
two observations.

Box C explanation continued


Observation 3:
US users are not buying these 10 pounds when the

price is higher at $13 after the tariff.


Observation 4:
US producers were buying these 10 pounds of steel
when the price was lower at $9 before the tariff.

Box C explanation continued


Observation 3:
US users are not buying these 10 pounds when the

price is higher at $13 after the tariff. What does this tell
you about the maximum (average) value of steel?
The (average) value is at most $13.

Box C explanation continued


Observation 4:
US producers were buying these 10 pounds of steel

when the price was lower at $9 before the tariff.


What does this tell you about the minimum (average)
value of 1 pound of steel?
The (average) value is at least $9.

Box C explanation continued


So the maximum average value is $13.
And the minimum average value is $9.
A reasonable estimate of the average value is the

middle between the maximum and the minimum.


Therefore ($? + $?) divided by 2 = $? is a reasonable
estimate of the average value.
The total value of 10 pounds is then $? times 10 = $?,
which is in Box C.

Box D explanation
In Box D we see that the US as a whole has a loss of $?.
Here is an intuitive explanation of this loss.
Before the tariff, the US was buying steel at $9 per pound but the

value is estimated to be $? per pound.


After the tariff, the US is not buying those 10 pounds. The US is
no longer paying $9 per pound so that is a saving. However, since
we are not buying the steel, we also lose the $? value from steel.
So the net loss to the US is $2 per pound ($? value we are not
getting minus the $9 saving).
$? per pound times 10 pounds is $?.
This explanation is intuitive and is a short-cut.
There is still value in doing the long table. We are sure that we
have accounted for everything and that we have not left anything
out.

Box D explanation continued


The technical name for the $? loss in Box D is:
Change in consumer surplus.
It is also called the deadweight loss due to

consumption distortion.
With a tariff, the US is under-using steel by 10 pounds.
Those 10 pounds should have been imported at $9 per
pounds to generate $11 per pound in value. We call this
under-consumption a consumption distortion.

Box D explanation continued


The $? loss can also be calculated as the area of a (right-

angle) triangle.
Height is
$?

Base is 10 pounds

The base is the decrease in US usage of steel due to the

tariff.
The height is the increase in US price of steel due to the
tariff (from $9 to $13).
The area of this triangle is base times height divided by 2 =
10 times ? divided by 2 = ?
So the deadweight loss is also called a deadweight loss
triangle.

Now we can put the four tables together to get an

overall net gain/loss to the US as a whole.


Table 5
Overall Net Effect on US as a Whole

Table 1

Table 2

Table 3

Table 4

Overall net effect of a tariff

So in this example, the overall net effect on the US is a ? of

$?. In this case, the tariff is ? for the US as a whole.


However, this will not always be the case.
Note that Table 1 will always show no gain or loss.
Table 2 and 4 will always show a loss. That is why they are
called deadweight losses you cannot avoid them as long
as there is a tariff.
The only gain comes from Table 3. If the gain in Table 3 is
large enough, it can offset the deadweight losses in Tables 2
and 4. If the gain in Table 3 is small, a tariff will result in an
overall net loss to the US as a whole.