2 management - School of International Business and ...

159 The Puzzle of Globalization
2a The large country case
Let us suppose that there are only two trading countries where the autarky equilibrium
price in country I (pi(A)) is higher than in country II (pII(A)). Under free trade the supply of II
(SF) and the demand of I (DF) are in equilibrium at the price pI, II (F). The trade volume is
xF xF* = xI(F) xI(F)* = xII(F) xII(F)*. If the large country I introduces a tariff (t), the domestic
price will increase to pI(t) and the price in the exporting country will decrease to pII(t). The
tariff reduces the trade volume to x(F) x(t) = xI(t) xI(t)*) = xII(t) xII(t)*.
The actors in country I and II are affected as follows (table below): As in the case of a small
country, the producer effi ciency (A) and the consumer surplus (A+B+C+D) decrease, whe-
reas the government’s tariff revenue increases more than in the small country case (C+G).
G results from the positive terms of trade effect. The lower price in the exporting country II
increases the surplus of the consumers in this country (e+f+g+h), but reduces the produc-
tion (and employment) and the surplus of the producers (e), partly because their terms of
trade deteriorate. When summing up the welfare effects in countries I and II, the result is
a decrease in world welfare. It depends on the amount of the tariff as well as on the elas-
ticity of the four private actors whether the world welfare loss is high or low and who has
to bear the larger part of this loss. The lower the elasticity compared to the trading partner,
the higher is the part of the welfare loss that a country has to bear. Identical supply and
demand elasticities in both countries lead to an equal burden share of the tariff.