Q6
(a) Explain the price effect, protective effect, consumption effect, revenue effect and distributive effect of tariff in partial equilibrium framework. 20 (b) Define the concepts of trade creation and trade diversion. Explain their role in the context of gains from trade bloc. 5+10=15 (c) Do you think that perfect capital mobility under fixed exchange rate improves the effectiveness of fiscal and monetary policies ? Explain. 15
हिंदी में प्रश्न पढ़ें
(a) आंशिक संतुलन ढांचे में सीमा-शुल्क (टैरिफ) के मूल्य प्रभाव, संरक्षणात्मक प्रभाव, उपभोग प्रभाव, राजस्व प्रभाव एवं वितरण प्रभाव की व्याख्या कीजिए। 20 (b) व्यापार सृजन और व्यापार विचलन की अवधारणाओं को परिभाषित कीजिए। व्यापार समूह (ट्रेड ब्लॉक) से व्युत्पन्न लाभ के संदर्भ में उनकी भूमिका की व्याख्या कीजिए। 5+10=15 (c) क्या आपको लगता है कि स्थिर विनिमय दर के अंतर्गत पूर्ण पूंजी गतिशीलता, राजकोषीय और मौद्रिक नीतियों की प्रभावशीलता में सुधार करती है ? समझाइए। 15
Directive word: Explain
This question asks you to explain. The directive word signals the depth of analysis expected, the structure of your answer, and the weight of evidence you must bring.
See our UPSC directive words guide for a full breakdown of how to respond to each command word.
How this answer will be evaluated
Approach
The directive 'explain' demands clear exposition with causal reasoning across all three parts. Allocate approximately 40% of time/words to part (a) given its 20 marks, 30% each to parts (b) and (c). Structure: brief introduction on trade policy relevance → systematic treatment of (a) with diagrams → (b) with Viner's analysis → (c) with Mundell-Fleming exposition → concluding synthesis on trade-offs between protection and openness.
Key points expected
- Part (a): Price effect (domestic price rises by full tariff amount under small country assumption), protective effect (production expansion from S1 to S2), consumption effect (contraction from D1 to D2), revenue effect (government tariff revenue), and distributive effect (consumer surplus loss, producer surplus gain, deadweight losses) — all derived from partial equilibrium framework with demand-supply diagram
- Part (b): Trade creation (shifting from high-cost domestic production to low-cost partner production) and trade diversion (shifting from low-cost non-member to high-cost member production) — Viner's concepts applied to evaluate net welfare effects of customs unions/free trade areas
- Part (c): Perfect capital mobility with fixed exchange rate makes monetary policy ineffective (BP curve horizontal, LM shifts neutralized by capital flows) while fiscal policy becomes highly effective (no crowding out, IS shifts fully transmit to output) — Mundell-Fleming model conclusions
- Integration: Recognition that partial equilibrium tariff analysis assumes no retaliation, while strategic trade policy and optimal tariff theory modify conclusions; empirical applicability to India's trade liberalization experience post-1991
- Critical nuance: For part (c), distinction between short-run effectiveness versus long-run sustainability of fixed exchange rate with perfect capital mobility; relevance of impossible trinity constraint
Evaluation rubric
| Dimension | Weight | Max marks | Excellent | Average | Poor |
|---|---|---|---|---|---|
| Concept correctness | 22% | 11 | Precise definitions of all five tariff effects in (a) with correct directional changes; accurate distinction between trade creation and diversion in (b) with welfare implications; flawless application of Mundell-Fleming conditions for (c) including the impossible trinity constraint | Generally correct definitions but some confusion between protective and consumption effects, or incomplete grasp of why monetary policy becomes ineffective under fixed rates with perfect capital mobility | Fundamental errors such as confusing partial with general equilibrium, misidentifying trade creation/diversion, or claiming monetary policy remains effective under fixed exchange rate with perfect capital mobility |
| Diagram / model | 22% | 11 | Three distinct, correctly labeled diagrams: (a) partial equilibrium tariff diagram with world price, tariff-inclusive price, and all welfare areas marked; (b) Viner's trade creation/diversion geometry; (c) Mundell-Fleming IS-LM-BP with horizontal BP curve showing fiscal expansion effectiveness and monetary policy ineffectiveness | Two correct diagrams with minor labeling errors or missing welfare areas; OR correct diagrams but inadequate explanation of their construction | Single diagram or none; seriously misdrawn curves (e.g., upward sloping BP for perfect capital mobility); diagrams presented without integration into explanation |
| Quantitative reasoning | 16% | 8 | Explicit decomposition of tariff welfare effects into measurable components (consumer surplus loss = a+b+c+d, producer gain = a, revenue = c, deadweight = b+d); numerical illustration of trade creation gains versus diversion losses; algebraic derivation of policy multipliers under Mundell-Fleming conditions | Qualitative mention of welfare triangles without precise area identification; general statement that fiscal multiplier equals 1/(1-c) without derivation under open economy conditions | No quantitative treatment; purely verbal exposition without any measurable welfare analysis or multiplier discussion |
| Indian / empirical examples | 20% | 10 | For (a): India's tariff reduction post-1991 and consumer welfare gains; for (b): ASEAN-India FTA trade creation in electronics versus diversion concerns in agriculture; for (c): India's managed float experience 1991-2013 and capital control effectiveness during taper tantrum 2013 | Generic mention of India's trade liberalization or SAFTA without specific sectoral analysis; reference to 1991 crisis without connecting to Mundell-Fleming framework | No Indian examples; purely theoretical treatment or inappropriate examples (e.g., using US-China trade war for tariff effects without adaptation) |
| Policy implication | 20% | 10 | Synthesized policy conclusions: optimal tariff theory and retaliation risks in (a); rules of thumb for welfare-enhancing customs unions (high pre-union tariffs, competitive partners) in (b); exchange rate regime choice implications for macroeconomic policy autonomy in (c) — with explicit reference to India's current account management and capital account convertibility debate | Separate policy points for each part without synthesis; standard conclusions without critical evaluation of assumptions (e.g., small country, no retaliation) | No policy implications drawn; or contradictory recommendations (e.g., advocating simultaneous use of monetary and fiscal policy under fixed exchange rate with perfect capital mobility) |
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