Tariffs – Large Country

(a) Illustrating your answer by partial equilibrium diagrams representing the home market of a large importing country and the world market, explain the price, quantity and welfare effects of a tariff imposed by a large country. What does your analysis indicate about why large countries might be tempted to use tariffs to improve their economic welfare? (10 marks) (b) Explain why this strategy (use of tariffs by a large country in order to improve its economic welfare) is likely to be self-defeating. (3 marks) (c) Illustrating your answer by means of an appropriate diagram, explain how and why rational tariff policy decisions by two large countries can result in a Nash equilibrium where both countries apply tariffs to each other’s goods and neither is prepared to remove their tariffs. Why can this outcome be described as a “Prisoner’s Dilemma”? (8 marks) (d) How can conditions be created that allow an escape from this “Prisoner’s Dilemma”? Briefly explain the features of the GATT/WTO approach to trade liberalisation that could be interpreted as providing a way out from the “Prisoner’s Dilemma”. (e) Briefly explain how the political economy approach provides an alternative rationale for trade agreements. (3 marks) (f) What are some of the explanations advanced for the increasing popularity of free trade agreements and other preferential trade agreements from the mid-1990s onward? Include an explanation of the view that changes in the way that international trade is conducted, pressure for new trade rules to take account of these changes, and difficulties faced in developing an adequate response to these pressures within the WTO system, may have contributed to the increased emphasis placed by government on increasing their involvement in preferential trade agreements. (8 marks)