If a nation fitting the criteria for the large nation model imposes an import tariff

 Options:

a. the domestic price of the product will increase by more than the tariff itself b. the domestic price of the product will increase by the same amount as the tariff c. the domestic price of the product will increase by less than the tariff d. none of the above

The Correct Answer Is:

c. the domestic price of the product will increase by less than the tariff

Correct Answer Explanation: c. The domestic price of the product will increase by less than the tariff.

An import tariff is a tax imposed on imported goods and services. When a nation levies an import tariff, it aims to make imported products more expensive, thus encouraging domestic consumers to buy locally-produced goods. However, the extent of the price increase in the domestic market is not solely dependent on the tariff rate.

Several factors influence how much the domestic price will rise:

• Market Dynamics: The elasticity of demand and supply plays a crucial role. If the demand for the imported product is relatively inelastic (insensitive to price changes), a tariff might result in a smaller price increase. Conversely, if the demand is elastic, the price increase might be closer to the tariff rate.
• Passing on the Cost: Importers or domestic distributors might absorb a portion of the tariff to remain competitive. They could choose not to pass on the entire tariff cost to consumers, moderating the price hike.
• Competitive Pressures: Domestic producers might not increase prices to the full extent of the tariff to maintain competitiveness against imported goods. They may use the tariff as an opportunity to capture market share by offering a more competitive price.
• Government Policies or Subsidies: Sometimes, governments implement policies to mitigate the impact of tariffs, such as subsidies to domestic producers. This action could prevent a full pass-through of the tariff cost to consumers.

Therefore, in most cases, the domestic price increase will be less than the imposed tariff due to these market dynamics and strategic business decisions.

Why Other Answers Are Not Correct:

a. “The domestic price of the product will increase by more than the tariff itself”:

Explanation of Inaccuracy:

• Market Dynamics Ignored:

This statement overlooks the elasticity of demand and supply. If the demand for the product is relatively inelastic, the increase in the domestic price might be disproportionately lower than the tariff. In contrast, in a more elastic market, the price hike might be closer to the tariff rate.

• Business Strategy and Competition:

Importers or domestic distributors might strategically choose not to pass on the full tariff cost to consumers. They might absorb a portion of the tariff themselves to maintain market share or competitiveness, thereby preventing the domestic price hike from surpassing the tariff.

• Government Intervention:

Government policies, subsidies, or incentives to domestic producers can mitigate the tariff’s impact. Such measures can prevent the full cost from being transferred to consumers, thereby limiting the extent of the price increase.

• Oversimplification:

This option assumes a direct one-to-one correlation between the tariff rate and the domestic price increase without considering the complex interplay of various market forces that affect pricing decisions.

b. “The domestic price of the product will increase by the same amount as the tariff”:

Explanation of Inaccuracy:

• Neglect of Market Dynamics:

This option oversimplifies the relationship between tariffs and domestic prices. It assumes a perfect pass-through of the entire tariff cost to consumers, disregarding elasticity of demand and supply, which significantly influences the degree of price increase.

• Business Decision-Making:

Importers or domestic distributors might not transfer the full tariff cost to consumers. They could absorb a portion of the tariff to remain competitive or to prevent a significant reduction in sales.

• Government Interventions:

Various government policies or subsidies might offset the impact of tariffs, preventing the full burden from being borne by consumers.

• Limited Scope:

The assumption of an identical increase in domestic prices as the tariff doesn’t consider the diverse range of products, markets, and business strategies that can affect how much of the tariff cost is passed on to consumers.

d. “None of the above”:

Explanation of Inaccuracy:

• Overgeneralization:

This option disregards the reality that while the impact of tariffs on domestic prices is variable, there are clear influencing factors that generally result in the domestic price increase being less than the tariff. It overlooks the complexities and nuances involved in pricing decisions.

• Omission of Influencing Factors:

By suggesting none of the provided options are correct, it ignores market dynamics, business strategies, elasticity of demand, competitive pressures, and government interventions, which are crucial determinants in shaping how tariffs affect domestic prices.

In summary, each of the incorrect options oversimplifies the relationship between tariffs and domestic prices, disregarding the multifaceted nature of markets, business decisions, and governmental interventions that influence how much of the tariff cost is ultimately passed on to consumers.

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