Suppose the world price of automobiles is $20,000 and automobile manufacturers in Country A use $10,000 worth of imported inputs and no domestic inputs. What is the effective rate of protection for the automobile industry in Country A, if there is a tariff of 25 percent on imported automobiles and a tariff of 50 percent on imported inputs used in this industry?
What will be an ideal response?
POSSIBLE RESPONSE: The effective rate of protection for an industry is measured as the percentage change in the value added per unit which results from all protective measures on inputs and the final good. With free trade, the value added for an automobile is ($20,000 ? $10,000) = $10,000. When a tariff of 25 percent is imposed on imported automobiles, the new price for an automobile rises to $25,000. Accounting for the tariff on imported inputs, the new value of the inputs is $15,000. The new value added for an automobile is ($25,000 ? $15,000) = $10,000. The effective rate of protection for the automobile industry in Country A is therefore ($10,000 ? $10,000) / $10,000 = 0%.
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