A’s offer curve We have seen how to derive an ‘offer curve’, showing combinations of exports offered in exchange for imports at different price levels.  Charles van Marrewijk “Optimal” tariffs; 1 A’s import A’s export

Look at point C; on the price line it is the best deal available to country A Obviously, if country A would get more imports for the same exports its welfare would rise A’s import A’s export A’s offer curve C  Charles van Marrewijk “Optimal” tariffs; 2

U0U0 U2U2 Welfare for country A increases to the north- west: U 0 < U 1 < U 2 A’s import A’s export U1U1 A’s offer curve This implies that through each point on the offer curve we can draw an Iso-welfare curve for country A. This curve must be tangent to the price line from the origin through that point.  Charles van Marrewijk “Optimal” tariffs; 3

U0U0 U2U2 Maximizes country A’s welfare given this restriction at point D: no tariffs An omniscient central planner A’s import A’s export U1U1 A’s offer curve If country A is a country ROW offer curve D  Charles van Marrewijk “Optimal” tariffs; 4 smallThe offer curve it faces from the Rest of the World (ROW) is a straight line (country A cannot influence its terms of trade)

ROW offer curve U0U0 U2U2 does not maximize country A’s welfare given this restriction at point D An omniscient central planner A’s import A’s export U1U1 A’s offer curve If A is a countryThe ROW offer curve is not a straight line (country A can influence its terms of trade) large D  Charles van Marrewijk “Optimal” tariffs; 5

U0U0 U2U2 using an “optimal” tariff such that the new offer curve intersects at point E Country A’s offer curve A’s import A’s export U1U1 old A’s welfare the ROW offer curve is maximized at point E This gives the central planner an incentive to manipulate given D ROW offer curve U3U3 E new  Charles van Marrewijk “Optimal” tariffs; 6

Through each point on the ROW offer curve is an iso- welfare curve tangent to a line through the origin. ROW export ROW import For ROW, however, the situation is reverse Welfare increases to the south-east  Charles van Marrewijk “Optimal” tariffs; 7

ROW export, A’s import ROW import, A’s export ROW, therefore, has an incentive to manipulate D F new  Charles van Marrewijk “Optimal” tariffs; 8 its offer curve through ‘optimal’ tariffs to go from point D to point F

ROW wants to be clever to move from D to F ROW export, A’s import ROW import, A’s export D F new E G The end result of all this cleverness is a move from D to G; everyone is worse off retaliation  Charles van Marrewijk “Optimal” tariffs; 9 may worsen the situation Further A wants to be clever to move from D to E