Reading the scenario
Take a small open economy, a price-taker on the world market, importing a standardised good. All figures are ETG teaching figures, not from any exam paper. Price P is in dollars per unit and quantity Q is in thousands of units.
- Domestic demand: Qd = 100 - 2P
- Domestic supply: Qs = 2P
- World price (free trade): Pw = $10
- Policy under study: a specific (per-unit) tariff of $5
Because the country is small, it can buy any quantity at the world price, so the world supply to this market is horizontal at the prevailing price.
Step 1: the free-trade position
At the world price of $10, read quantities off the domestic schedules:
Domestic demand: Qd = 100 - 2(10) = 100 - 20 = 80 thousand units.
Domestic supply: Qs = 2(10) = 20 thousand units.
Imports fill the gap between what consumers buy and what domestic firms supply:
Imports (free trade) = Qd - Qs = 80 - 20 = 60 thousand units.
Step 2: the position after the $5 tariff
A $5 specific tariff raises the price paid in the domestic market to Pw + tariff = 10 + 5 = $15. Re-read the schedules at $15:
Domestic demand: Qd = 100 - 2(15) = 100 - 30 = 70 thousand units.
Domestic supply: Qs = 2(15) = 30 thousand units.
Imports now fill the smaller gap:
Imports (with tariff) = 70 - 30 = 40 thousand units.
Step 3: the change in imports
Change in imports = imports with tariff - imports under free trade = 40 - 60 = -20 thousand units. The tariff cuts imports by 20 thousand units, partly because consumers buy 10 thousand fewer (80 to 70) and partly because domestic firms supply 10 thousand more (20 to 30).
Step 4: government revenue
Tariff revenue is the per-unit tariff multiplied by the quantity still imported (domestic output is not taxed):
Revenue = tariff x imports with tariff = $5 x 40 thousand = $200 thousand.
Step 5: the welfare loss
A tariff creates a deadweight welfare loss made of two triangles: a production-distortion triangle (domestic firms now supply units that the world could have produced more cheaply) and a consumption-distortion triangle (consumers who valued the good above the world price but below the tariff-inclusive price now go without). Each has the $5 tariff as its height.
Production distortion. Domestic output rose from 20 to 30 thousand, a base of 10 thousand units:
Loss = 1/2 x base x height = 1/2 x 10 x 5 = $25 thousand.
Consumption distortion. Domestic demand fell from 80 to 70 thousand, a base of 10 thousand units:
Loss = 1/2 x base x height = 1/2 x 10 x 5 = $25 thousand.
Total welfare loss = 25 + 25 = $50 thousand. This is net of the $200 thousand revenue and of the gains to domestic producers; it is the cost to society that no one recovers.
Recommendation
On these numbers I recommend against the tariff. It does raise $200 thousand for the government and lifts protected domestic output from 20 to 30 thousand units, which is why it is politically tempting. But it does so by pushing the price up from $10 to $15 for every domestic buyer, transferring income from consumers to producers and the treasury, and it leaves a pure deadweight loss of $50 thousand that nobody recovers. If the genuine aim is to support domestic firms or workers, a production subsidy aimed only at the supply side, or direct assistance with retraining, reaches that goal with a smaller welfare loss because it avoids the consumption distortion that the tariff imposes on buyers.
The recommendation is conditional. A temporary tariff can be defended for a genuine infant industry with a credible path to competitiveness, or as a short-run response to dumping, provided it is time-limited and reviewed, since open trade also offers the gains from comparative advantage that this small economy would otherwise forgo. The retaliation risk matters too: if trading partners answer with tariffs of their own, this country's exporters lose, which can dwarf the $200 thousand raised here. Weighing the $50 thousand welfare loss and the higher consumer price against a modest revenue gain, freer trade with targeted, less distorting domestic support is the stronger policy.