Trade Policy & Tariffs
Draw the world price as a horizontal line against domestic S and D: above the autarky price ⇒ exports, below ⇒ imports. A tariff produces two deadweight loss triangles, d + f — never one.
Reading the diagram
The world price is a horizontal line because the country is a price taker: world supply and demand at that price are perfectly elastic. Mark QS and QD on it; the horizontal gap between them is exports or imports.
Trade moves jobs rather than destroying them
Run it through MRPL = MPL × MR. In an export industry the world price exceeds the old domestic price, so MR rises, labor demand shifts up, wages and employment rise. In an import-competing industry MR falls and labor demand shifts down. Trade rearranges jobs rather than raising or lowering total employment — but brutally for workers who cannot move to the new jobs.
The China Shock
- The old consensus
- Trade did not much jar labor markets: manufacturing employment had declined since roughly the Korean War, earlier liberalizations caused no big dislocations, US wage inequality emerged before large trade changes. Theory said displaced workers move; impacts stay diffuse.
- What broke it
- China's WTO accession in late 2001. Autor, Dorn and Hanson showed it hit geographic agglomerations — commuting zones concentrated in exposed industries — which did not recover. Manufacturing and total employment fell persistently; older workers moved onto disability and, in some accounts, opioids.
- The paired towns
- North Hickory, NC — furniture, high manufacturing share, few graduates — versus Raleigh-Cary, similarly exposed but larger, diversified, more educated. Raleigh-Cary ended up far better off. Concentration and adjustment capacity did the damage, not exposure.
Tariffs
Protection comes as tariffs (a tax on imports), quotas (a quantity limit), or subsidies to domestic production. A tariff raises the domestic price to Pworld + tariff, pulling production up and consumption down, squeezing imports from both sides.
What tariffs do and do not do
- Employment
- Likely raises it in the protected industry, probably not in total. Retaliation cuts foreign demand for exports; the currency may appreciate, hurting exporters (Unit 24); other industries face higher input costs.
- Legitimate arguments
- National security; supply chain disruption; diversification; infant industry and dynamic comparative advantage; jobs for particular workers; positive domestic externalities. Edwards adds a dry final item: capriciousness and punishment.
- Not just policy
- Shipping costs, logistics and communication matter. The 1950s container ship transformed trade by cutting out the stevedores who controlled loading.
Rules that earn points
- Domestic S and D, then the horizontal world price line. Above autarky ⇒ exports; below ⇒ imports.
- Mark QS and QD at the world price and label the horizontal gap.
- For a tariff, add a second horizontal line at Pworld + tariff and mark the new QS and QD.
- Revenue is the rectangle over the remaining imports. Draw two deadweight loss triangles, one on each side.
- Drawing only one deadweight loss triangle for a tariff. There are two: d and f.
- Putting tariff revenue over total imports. It is only the imports that still occur.
- Claiming tariffs raise total employment. They shift it, and retaliation and currency appreciation push back.
On a domestic supply and demand diagram, the world price is drawn below the price that would clear the domestic market on its own. Then:
- AThe country exports, and the gap between QS and QD is exports
- BThe country imports, and the gap between QD and QS is imports
- CThe country neither imports nor exports, since the domestic market clears
- DDomestic producers supply more than before, since the price is lower
Answer
B — the country imports.
At the lower world price domestic consumers want more and domestic producers supply less. The horizontal gap QD − QS is filled by imports.
A is the direction flip — it is the export case, which needs the world price above autarky.
Using the standard lettering, the deadweight loss from a tariff is:
- Ad only
- Bc + e
- Cd + f
- Dc + d + e + f
Answer
C — d + f.
d is production inefficiency: high-cost domestic output replacing cheaper imports. f is consumption inefficiency: buyers whose willingness to pay exceeded the world price but not the tariffed price.
D is the trap: it counts the transfers as losses. c goes to domestic producers and e goes to the government — consumers lose them, but nobody burns them.
A country opens to trade. In its import-competing industry, MRPL = MPL × MR implies:
- ALabor demand shifts up, because MPL rises with foreign competition
- BLabor demand shifts down, because MR falls with the output price — wages and employment fall
- CLabor supply shifts out as displaced workers enter
- DTotal national employment falls by the number of jobs lost in that industry
Answer
B — MR falls, so labor demand shifts down.
The world price is below the old domestic price in an import-competing industry, so MR falls and labor demand falls with it.
D is the trap: it stops the story halfway. Export industries see MR rise and labor demand shift up. Trade rearranges jobs rather than raising or lowering total employment — though the rearrangement can be brutal for workers who cannot move.
Why did the China Shock hurt so much more than earlier trade liberalizations?
- AIt reduced total US employment, which earlier episodes did not
- BIt hit geographically concentrated commuting zones that were undiversified and less educated, and they did not recover
- CThe level of import exposure was higher than anything seen before
- DUS manufacturing employment began falling for the first time in 2001
Answer
B — geographic concentration and weak adjustment capacity.
Autor, Dorn and Hanson found commuting zones built around exposed industries suffered persistent falls in manufacturing and total employment, with older workers moving onto disability.
C is the trap, and the paired towns refute it: North Hickory, NC and Raleigh-Cary had similar exposure, but Raleigh-Cary was larger, diversified and more educated and ended up far better off. D is simply wrong — manufacturing employment had been declining since roughly the Korean War.
Draw the welfare effects of a tariff on an imported good. Identify every region, state who gains and who loses, and give the deadweight loss.
Model answer
With the tariff the domestic price rises to Pworld + tariff. Domestic QS rises, domestic QD falls, and imports shrink from both ends.
| Before | After | |
|---|---|---|
| Consumer surplus | a+b+c+d+e+f | a+b |
| Producer surplus | g | c+g |
| Tariff revenue | — | e |
| Total surplus | a+b+c+d+e+f+g | a+b+c+e+g |
Deadweight loss = d + f. Region d is production inefficiency — high-cost domestic output displacing cheaper imports. Region f is consumption inefficiency — buyers priced out whose willingness to pay exceeded the world price. Regions c and e are transfers, to producers and government, not losses.
- Two horizontal price lines, Pworld and Pworld + tariff.
- New QS and QD both marked — imports squeezed from both sides.
- Revenue drawn as the rectangle over the remaining imports, not total imports.
- Two deadweight triangles named, d and f, with the right interpretation of each.
- Saying explicitly that c and e are transfers rather than losses.
Soybeans are planted in spring and harvested in fall. Farmers have already planted when a trade war halts Chinese purchases. The crop cannot be stored or destroyed. Use a diagram to show how far the price must fall, and explain the policy response.
Model answer
Once the crop is in the ground, supply is perfectly inelastic — a vertical line at the already-planted quantity QSUS. With world demand gone, the entire crop must clear in the domestic market alone.
The price therefore falls all the way down to the domestic demand curve read at QSUS — a very large reduction, far below the old world price. Hence the soybean bailouts: $23 billion in the first Trump term, with $10–12 billion more planned in 2025.
- Supply drawn vertical, and named perfectly inelastic — the planting timing is the reason.
- Reading the new price off the domestic demand curve at that fixed quantity.
- Saying the fall is large, and why — no storage, no destruction, no foreign buyer.
- Naming the bailout as the policy response, with a figure.