Domestic demand and Excess demand and
supply in Home (the supply (the world
importing country). market).
Parameters of Home's
domestic supply.
Parameters of Home's
domestic demand.
Tariff level in Home (use
the spinner to control).
Equilibrium prices and
quantities in Home in
autarky.
Equilibrium prices and
quantities in Home with
free trade.
Equilibrium prices and
quantities in Home with
the tariff in place.
Difference in surplus for
Welfare levels for Home Home relative to free
in autarky. trade (gain/loss from
intervention).
Welfare levels for Welfare levels for Home
Home with free trade. Difference in surplus for with tariff in place.
Home relative to
Home with free trade. Difference in surplus for
Home relative to
autarky (gains from
trade).
cess demand and Domestic demand and
upply (the world supply in Foreign (the
market). exporting country).
Parameters of Foreign's
domestic demand.
Export tax level in
Foreign (use the spinner
to control).
Parameters of Foreign's
domestic supply.
Equilibrium prices and
quantities in Foreign in
autarky.
Equilibrium prices and
quantities in Foreign
with free trade.
Equilibrium prices and
quantities in Foreign
with the export tax in
place.
ence in surplus for
e relative to free Welfare levels for
e (gain/loss from Foreign (same as for
ntervention). Home).
els for Home
Simulation of the Effect of a Trade
Domestic Demand Domestic Supply Free Trade Price
Free Trade Price Trade War Price Excess Demand
500 500
400 400
300 300
Price
Price
200 200
100 100
0 0
0 50 100 150 200 250 300 0 50 100
Quantity
Home Steel Market
Inverse Demand Inverse Supply
Intercept 500.0 Intercept 50.0
Slope -2.0 Slope 2.0
Tariff ($) 0.0 #
Home Autarky Equilibrium
Price 275.0 Consumer Surplus 12656.3
Quantity Demanded 112.5 Producer Surplus 12656.3
Quantity Supplied 112.5 Govt Revenue 0.0
Imports 0.0 Total Surplus 25312.5
Home Free Trade Equilibrium
Price 220.0 Consumer Surplus 19600.0 6943.8
Quantity Demanded 140.0 Producer Surplus 7225.0 -5431.3
Quantity Supplied 85.0 Govt Revenue 0.0 0.0
Imports 55.0 Total Surplus 26825.0 1512.5
Home Trade War Equilibrium
Price 220.0 Consumer Surplus 19600.0 0.0
Quantity Demanded 140.0 Producer Surplus 7225.0 0.0
Quantity Supplied 85.0 Govt Revenue 0.0 0.0
Imports 55.0 Total Surplus 26825.0 0.0
lation of the Effect of a Trade War
Free Trade Price Trade War Price Domestic Demand Domestic Supply
Excess Demand Excess Supply Free Trade Price Trade War Price
500
400
300
Price 200
100
0
100 150 200 250 300 0 50 100 150 200 250 300
Quantity Quantity
Foreign Steel Market
Inverse Demand Inverse Supply
Intercept 250.0 Intercept 10.0
Slope -2.0 Slope 3.0
Export Tax ($) 0.0 #
Foreign Autarky Equilibrium
Price 154.0 Consumer Surplus 2304.0
Quantity Demanded 48.0 Producer Surplus 3456.0
Quantity Supplied 48.0 Govt Revenue 0.0
Exports 0.0 Total Surplus 5760.0
Foreign Free Trade Equilibrium
Price 220.0 Consumer Surplus 225.0 -2079.0
Quantity Demanded 15.0 Producer Surplus 7350.0 3894.0
Quantity Supplied 70.0 Govt Revenue 0.0 0.0
Exports 55.0 Total Surplus 7575.0 1815.0
Foreign Trade War Equilibrium
Price 220.0 Consumer Surplus 225.0 0.0
Quantity Demanded 15.0 Producer Surplus 7350.0 0.0
Quantity Supplied 70.0 Govt Revenue 0.0 0.0
Exports 55.0 Total Surplus 7575.0 0.0
Exercises
1. Large Country and Optimal Tariffs
The large country tariff argument is one of the oldest arguments for protection. As Home increases its tariff (use
the spinner next to cell D31), the world price falls and total surplus rises. In effect, Home exploits its monopsony
power to extract a lower price from Foreign. But this process cannot continue forever, Home is still limited by
Foreign's willingness to supply. As you increase the tariff, keep a close eye on total surplus in Home. Eventually
its rate of increase will slow, and then it will fall. When you find the tariff that maximizes total surplus, you have
determined the 'optimal' tariff. Points to note: 1) Tariff revenue will still be increasing at the optimal tariff. Can
you find the revenue maximizing tariff? It must be larger than the optimal tariff. 2) The optimal tariff depends on
the elasticity of foreign supply. Try decreasing the slope of the Foreign supply curve (cell P30). What happens to
the optimal tariff of Home? You should find that the optimal tariff is smaller. The reason is that the elasticity of
2. Trade Wars and Retaliation
A trade war can be simulated in which the countries alternately impose optimal tariffs (export taxes) on each
other, taking the intervention imposed by the other country as given. Start by finding the optimal tariff for
Home. Now find the optimal Foreign response, leaving the original intervention in place. Since welfare increases,
it is in Foreign's interest to respond to the original tariff. Once Foreign does respond, what is the best option for
Home? Perhaps surprisingly, it is in Home's best interest to lower its original tariff. After a few rounds, we reach
a point where neither country can move without lowering total surplus. This is a Nash equilibrium. Points to
note: 1) Total surplus is lower for both countries at the end of the war relative to free trade. For some
configurations of demand and supply it is possible that one country may be better off, but not both. 2) The
3. Countervailing Export Subsidies
The sheet can handle subsidies too, which are just negative taxes. Consider an export subsidy imposed by
Foreign (a negative value in cell M31). What are the consequences? For Foreign the export subsidy forces the
world price down, in addition to introducing a deadweight loss. Home on the other hand experiences a net
welfare gain from its improved terms of trade. How should Home respond? From a net welfare perspective they
should do nothing, but domestic producers are hurt. Under WTO rules, Home can apply a countervailing duty
equal to the value of the export subsidy. To simulate this put a tariff of the same magnitude as the export
subsidy (it will be a positive value) in cell D31. What is the net result? The free trade world prices are restored -