Trade War between China and the US

This economics assignment discusses the impact of the trade war between China and the US on the prices of handbags and steel, consumer and producer surplus, and government revenue. It explains how the imposition of tariffs has affected the equilibrium price and quantity of handbags and steel in the US market, and how it has shifted the supply curve. The assignment also discusses the elasticity of demand for US-made cars and how it affects the price of cars in the market. The reference section includes sources on the tropical timber trade, world steel trade, and quantitative international economics.

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ECONOMICS ASSIGNMENT
TRADE WAR BETWEEN CHINA AND THE US

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Contents
Question 1.1...............................................................................................................................3
Question 1.2...............................................................................................................................4
Reference....................................................................................................................................7

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Question 1.1
Leather handbags exported from China are among the products that have been imposed with
high tariff in order to protect the domestic handbag producers of the US. Now, the market for
a handbag is a normal market with a downward sloping demand curve and upward sloping
supply curve. The equilibrium price for leather handbag in the US market is P0 which is
higher than the price of handbags in the Chinese market. The Chinese supply curve is
horizontal as any decrease in the price of handbags the supply will reduce to zero.
Figure 1: The import of handbags from the Chinese market
(Source: Presse, 2019)
Now as the US government has imposed a tariff on the handbags imported from china, the
effective price for the Chinese handbag has increased. Therefore the supply curve of China
has shifted upward equal to the value of the tariff imposed by the government of the US on
the handbags. P2 shows the increased price for handbag import from the market of China.

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Therefore, the consumer surplus reduces by the area shown as 1 in the above figure. Barbier
et al. (2019) stated that with the increase in price the area above the price and below the
demand curve reduces and hence the consumer surplus reduces.
The producers’ surplus of the domestic market of the US supplies and sold a higher quantity
of handbags in the market and hence at that price the surplus increases by the area shown as 1
in the figure. That means the surplus is shifted from the consumers to the producers.
The domestic demand at this increased price will reduce from Q4 to Q3 and the domestic
supply in the market will increase from Q1 to Q2. Bartz (2019) stated that the imposition of
the tariff allows some of the domestic firms to charge a price equal to the world price and
start operating at a higher price.
The import quantity is the difference between the domestic demand and the domestic supply
in the market of Handbags in the use. Q2 is the domestic supply for handbags at this price
which is lower than the domestic demand which is Q3. Thus, the shortage in supply of
handbags is met from importing the rests from China. Therefore the import quantity at this
price is Q3-Q2.
The US government budget is also made up of the tariff revenue generated by the
government of the country. As the tariff is imposed and a total quantity of Q3-Q2 is imported
from China, it earns revenue equal to the area shown as number 3 in the above figure. The
area of this yellow rectangle is the product of the number of handbags imported from china
and the total tariff imposed on the handbags.
Thus, due to the imposition of the tariff, producers gain the area of 1 which was held by the
consumers before the imposition. The government earns revenue equal to the area of 3 and
hence the 2 and 4 are held by no one. Therefore the overall welfare for the society will
reduce.
Question 1.2
The steel imported from the Chinese market is used in the production process of US-made
cars. The price for Chinese steel is lower than the equilibrium price for steel produced in the
US. Therefore, the imposition of the tariff has increased the price of Chinese steel as well.
Jones (2017) stated that there are few non-price factors which influence the supply curve in
the market. These include the increase in the price of raw materials, unfavourable weathers

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and many more. Therefore, in this case, the increase in the price of raw material which is
steel has shifted the supply curve to the left side. That means at each price level, the
carmakers of the US can produce fewer quantities of car.
Figure 2: The leftward shift in the supply curve due to the imposition of tariff on steel
(Source: Leamer and Stern, 2017)
The figure shows that the supply curve for cars in the US market has shifted leftward from S
to S1. The demand curve for the car has not changed because consumers of the market are not
directly affected by the increase in the price of steel. Now, this new supply curve and the
demand curve for car intersect at a point where the price is higher and the quantity sold is
lower than the case where there is no tariff on the Chinese steel. Due to the tariff, the price
increases from P1 to P2 and the quantity of cars sold in the market reduces from Q1 to Q2.

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Figure 3: The change in price and quantity in case of elastic demand
(Source: Kreps, 2019)
The increase in the price of cars in the market due to the increase in the price of steel depends
on the elasticity of demand for cars made in the US. If the demand for US cars in the market
is elastic that means the change in the quantity demanded is proportionately more than the
corresponding change in the price, the increase in the price of the car due to the increase in
the price of steel will be low. The figure shows that for the same shift in the supply curve the
price increased less than the increase in the tariff.

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Figure 4: The change in price and quantity in case of inelastic demand
(Source: Kreps, 2019)
Similarly, if the demand for the car in the market is inelastic in nature, then the increase in the
price of the car can be more than the increase in the import tariff on the Chinese steel (Bartz,
2019). Inelastic demand is when the change in quantity demanded is less than the
corresponding change in the price of that product. In the case of inelastic demand, the sellers
of the market pass on the tariff mostly to the consumers as they know that demand will
reduce proportionately lower than the increase in the price and hence the revenue will
increase.

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Reference
Barbier, E.B., Barbier, J.C.B., Bishop, J. and Aylward, B., 2019. The economics of the
tropical timber trade. Routledge, pp.132-145.
Bartz, D. (2019). Timeline: Key events in rapid escalation of US-China trade dispute.
[online] https://www.livemint.com. Available at:
https://www.livemint.com/Politics/9FwQLzQzAaA1O4zWy2FWDO/Timeline-Key-events-
in-rapid-escalation-of-USChina-trade-d.html [Accessed 16 Sep. 2019].
Jones, K., 2017. Politics vs economics in world steel trade. Routledge, pp.61-72.
Kreps, D.M., 2019. Microeconomics for managers. Princeton University Press, pp. 13-33.
Leamer, E.E. and Stern, R.M., 2017. Quantitative international economics. Routledge, pp.12-
74.
Presse, A. (2019). Trump says China called, requested to restart trade talks. [online] The
Straits Times. Available at: https://www.straitstimes.com/world/europe/trump-says-china-
called-requested-to-restart-trade-talks [Accessed 16 Sep. 2019].