I'm trying to finish up a macroeconomics correspondence course I have and I'm really struggling. There is a question that I dont quite understand and I was wondering if anybody here could help me out.

Basically it is asking about the effects of a country placing a duty on a good being imported from another country.

For example:

The USA is placing a tariff on softwood lumber being imported from Canada. How does this affect equilibrium income and the price level in the short run (of the Canadian economy)? How does it affect equilibrium income and price level in the long run (of the Canadian economy)? The Canadian government is going to increase program spending... will it offset the effects of the tariffs being placed on Canadian goods? What then, will happen to imflation?

... I'm thinking it would decrease supply which would increase the price level in the short run... not sure what that means for equilibrium income? a drop?

... in the long run I think it will decrease aggregate demand, the supply curve is fixed... so that means a price level drop I think

... I have no idea what government spending will do... increase aggregate expenditures and bring up equilibrium income?

Any help would be awesome, I'm confused!

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I'm your man!

quote Originally posted by doublec4: The USA is placing a tariff on softwood lumber being imported from Canada. How does this affect equilibrium income and the price level in the short run (of the Canadian economy)? How does it affect equilibrium income and price level in the long run (of the Canadian economy)? The Canadian government is going to increase program spending... will it offset the effects of the tariffs being placed on Canadian goods? What then, will happen to imflation?

Well, first of all, Equilibrium Economics is a myth. But...for the purpose of taking a test or solving a problem in a text book think of equilibrium income in terms of the law of diminishing returns. Keep in mind that most governments earned their tax revenues through tariffs until the late 19th century when income became the popular choice of taxation...popular for politicians at least. Tariffs offer many appeals in the near term because they defer income to outsiders. The effect however, as in the example above, is that supply is constrained by price increases in America. Hence, supply in Canada drops. Do you remember learning about aggregate demand? Govt purchases + Investment demand + Consumption demand = total output.

quote ... I'm thinking it would decrease supply which would increase the price level in the short run... not sure what that means for equilibrium income? a drop?

Correct. the extra cost to produce goods beyond the equilibrium point grows faster than the revenues.

quote ... in the long run I think it will decrease aggregate demand, the supply curve is fixed... so that means a price level drop I think

OK, I guess you DO remember aggregate demand

Price drop? Hmmm, yes and no. It depends on who you follow, Keynes or Modigliani, or Friedman, etc. In essence, supply is NOT fixed. I do not know what assumptions you are making so if you ASSUME supply is fixed then, yes, the price will drop.

quote ... I have no idea what government spending will do... increase aggregate expenditures and bring up equilibrium income?

Typically govt spending increases.

Keynes underestimates the marginal propensity to consume. Savings, however, is NOT the determining factor in spending as Modigliani asserts. Credit Card debt is the life blood of modern economies.

Any model you draw will have to take into consideration a variety of valiable including demand for lumber (housing starts primarily) cost per board foot of timber (Monday's WSJ will have that number), opportunity costs (steel framing instead of timber will envigorate the US steel industry and reduce deforrestation, etc.

Awesome! Huge + for you!

so I was on the right track...

what will these tarriffs and government spending do to inflation though? and why?

Will it increase inflation through the expectation of higher prices?

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[This message has been edited by doublec4 (edited 06-29-2006).]

quote Originally posted by Toddster: I'm your man! Typically govt spending increases. Keynes underestimates the marginal propensity to consume. Savings, however, is NOT the determining factor in spending as Modigliani asserts. Credit Card debt is the life blood of modern economies. Any model you draw will have to take into consideration a variety of valiable including demand for lumber (housing starts primarily) cost per board foot of timber (Monday's WSJ will have that number), opportunity costs (steel framing instead of timber will envigorate the US steel industry and reduce deforrestation, etc.

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quote Originally posted by doublec4: Awesome! Huge + for you! so I was on the right track... what will these tarriffs and government spending do to inflation though? and why? Will it increase inflation through the expectation of higher prices?

Sorry for the delay but I'm in San Diego for Westfest. Took the kids to the San Diego Zoo today so I'm sitting down in a nice air conditioned room catching-up on some posts.

ANYWAY....tariffs by themselves don't have a lot to do with inflation unless they are across the board. A tariff on lumber alone is not likely to cause an inflationary reaction in an economy that is not lumber dominant. Again, I need to know if your question is about the theory or the real world.

Typically government spending increases to protect tarriffed goods. But when lumber is the sole material there is only so much government spending that can be done. In America, we had this problem with grain and the government subsidized those industries to keep them producing. My feeling is that there is not likely to be a significant impact from lumber tarriffs alone. They WILL impact related industries like transportation, etc. so you may have an upturn in unemployment in related industries.

The impact of price expectations on inflation is a hotly debated issue. I personally do not see the link expect in very specific examples. for example, a gift shop sells umbrellas for $2 each, but when it starts raining his price changes to $5 each. This is one rare example where and expectation of price change is met because the free market concept does not apply, if you don't want to get wet you buy from the guy nearest to you and screw the price. Typically, in a free market system price expectations do not affect inflation because there is always a Wal Mart out there willing to sell cheap and beat expectations by sacrificing unit margin for volume. Others will disagree with me so be warned to regurgitate what ever your Prof. believes.

Thanks for the help again.

My entire economics course is based on theory. Its an introductory course to macroeconomics.

I'm really trying to make sense of everything in the course but there are a lot of theories and everything seems to be interconnected in a complicated manner. Hopefully I figure everything out before its time to write the exam! haha

Hi Toddster or anybody else that might know...

I have my exam on Monday and I'm just trying to clear up a couple more things...

I'm wondering how an increase in government spending will affect inflation (theoretically)...

I have also started another thread with a couple more questions I'm having trouble understanding.

Thanks!

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quote Originally posted by Toddster: Credit Card debt is the life blood of modern economies.

We are all DOOMED......