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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.

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

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).

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.

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.

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.

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.

information we need.

Before

No tariff on steel

After

$5 per pound tariff on steel

pounds less than before.

supply 30 pounds more than before.

$13

originally bought by US users before the tariff.

Table 1

20 pounds

supplied by US

producers

Table 2

Additional 30

pounds now

supplied by US

producers when

there is a tariff

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

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.

Observation 1:

US producers are producing and selling 30 pounds

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.

Observation 1:

US producers are producing and selling 30 pounds

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.

Observation 2:

US producers were not producing and selling these 30

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.

So the maximum average cost is $13.

And the minimum average cost is $9.

A reasonable estimate of the average cost is the middle

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

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.

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.

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

angle) triangle.

Height is

$?

Base is

30 pounds

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

revenue times ?

pounds = $?

increase in tariff

revenue

US as a whole

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

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.

Observation 3:

US users are not buying these 10 pounds when the

Observation 4:

US producers were buying these 10 pounds of steel

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

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.

Observation 4:

US producers were buying these 10 pounds of steel

What does this tell you about the minimum (average)

value of 1 pound of steel?

The (average) value is at least $9.

So the maximum average value is $13.

And the minimum average value is $9.

A reasonable estimate of the average value is the

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

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.

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.

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

angle) triangle.

Height is

$?

Base is 10 pounds

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.

Table 5

Overall Net Effect on US as a Whole

Table 1

Table 2

Table 3

Table 4

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.

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