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Import Tariffs and Quotas Under Perfect Competition 1 A Brief History of the World Trade Organization 2 The Gains from Trade 3 Import Tariffs for a Small.

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Presentation on theme: "Import Tariffs and Quotas Under Perfect Competition 1 A Brief History of the World Trade Organization 2 The Gains from Trade 3 Import Tariffs for a Small."— Presentation transcript:

1 Import Tariffs and Quotas Under Perfect Competition 1 A Brief History of the World Trade Organization 2 The Gains from Trade 3 Import Tariffs for a Small Country 4 Import Tariffs for a Large Country 5 Import Quotas 6 Conclusions 8

2 Chapter 2 of © 2007 Worth Publishers International Economics Feenstra/Taylor Chapter Outline Introduction A Brief History of the World Trade Organization The Gains from Trade Consumer and Producer Surplus Home Welfare No-Trade Free Trade for a Small Country Gains from Trade Home Import Demand Curve

3 Chapter 3 of © 2007 Worth Publishers International Economics Feenstra/Taylor Chapter Outline Import Tariffs for a Small Country Free Trade for a Small Country Effect of the Tariff Effect of the Tariff on Consumer Surplus Effect of the Tariff on Producer Surplus Effect of the Tariff on Government Revenue Overall Effect of the Tariff on Welfare Production Loss Consumption Loss Why are Tariffs Used?

4 Chapter 4 of © 2007 Worth Publishers International Economics Feenstra/Taylor Chapter Outline Import Tariffs for a Large Country Foreign Export Supply Effect of the Tariff Terms of Trade Home Welfare Foreign and World Welfare Import Quotas Import Quota in a Small Country Free Trade Equilibrium Effect of the Quota Effect on Welfare Allocation of Quota

5 Chapter 5 of © 2007 Worth Publishers International Economics Feenstra/Taylor Chapter Outline Costs of Import Quotas in the US Growth in Exports from China Welfare Cost of MFA Import Quality Reaction of the United States and Europe Conclusions

6 Chapter 6 of © 2007 Worth Publishers International Economics Feenstra/Taylor Learning Objectives Understand what a trade policy is and why it is used Understand the history of the World Trade Organization (WTO) and the General Agreement on Tariffs and Trade (GATT) Understand what a tariff is and why it is used Understand and be able to explain the effect of a tariff on a small country Understand and be able to explain the effect of a tariff on a large country

7 Chapter 7 of © 2007 Worth Publishers International Economics Feenstra/Taylor Learning Objectives Understand how a large country could potentially gain from implementing a tariff Understand what a quota is and why it is used Understand and be able to explain the effects of a quota on a country Understand how the quota can have costs even greater than tariffs

8 Chapter 8 of © 2007 Worth Publishers International Economics Feenstra/Taylor Introduction During the 2000 presidential campaign, President George W. Bush promised to consider implementing a tariff on the imports of steel This was a political move to secure votes in large steel-producing states as the tariffs would protect the domestic producers of steel The steel tariff is an example of a trade policya government action meant to influence the amount of international trade

9 Chapter 9 of © 2007 Worth Publishers International Economics Feenstra/Taylor Introduction Because gains from trade are unevenly spread, producers often feel the government should help them limit losses due to competition from trade Trade policy can include the use of import tariffs (taxes on imports), import quotas (limits on imports), and subsidies for exports This chapter will focus on the use of tariffs and quotas as trade policy The international governing body, the World Trade Organization (WTO), acts as a forum for trade issues between countries

10 Chapter 10 of © 2007 Worth Publishers International Economics Feenstra/Taylor Introduction We will look at the history of the WTO, beginning with its precursor, the General Agreement on Tariffs and Trade (GATT) We will then examine in detail the most commonly used trade policy, the tariff, looking at why they are used and the consequences of their use The chapter will also examine the use of import quotas, showing that although their costs are similar to tariffs, they can also be greater

11 Chapter 11 of © 2007 Worth Publishers International Economics Feenstra/Taylor Introduction Given the potentially greater costs of quotas, they have been greatly reduced under the WTO We will assume that firms are perfectly competitive. They produce a homogeneous good and are small compared to the market Under perfect competition, each firm is a price-taker in its market Imperfect competition will be evaluated in the next chapter

12 Chapter 12 of © 2007 Worth Publishers International Economics Feenstra/Taylor A Brief History of the World Trade Organization When peace was reestablished following WWII, representatives of 44 countries met in Bretton Woods, NH, to discuss the rebuilding of Europe and issues with high trade barriers and unstable exchange rates The outcome was an agreement outlining an international system of free trade, convertible currencies, and fixed exchange rates As part of this Breton Woods Agreement, the GATT was established in 1947 to reduce barriers to trade between nations

13 Chapter 13 of © 2007 Worth Publishers International Economics Feenstra/Taylor A Brief History of the World Trade Organization Under GATT, countries met periodically to negotiate for lower trade barriers between them Each meeting was named for the location where it took place and at the Uruguay Round, the WTO was established The WTO greatly expanded GATT by adding rules that govern an expanded set of global interactions through binding agreements The most recent round of the WTO was the Doha Round, in Doha, Qatar November 2001

14 Chapter 14 of © 2007 Worth Publishers International Economics Feenstra/Taylor A Brief History of the World Trade Organization Some Articles of GATT which still govern trade in the WTO: 1.A nation must extend the same tariffs to all trading partners that are WTO members. This is the most favored nation clause 2.Tariffs may be imposed in response to unfair trade practices such as dumping 3.Countries should not limit the quantity of goods and services that they import. Article XI states that countries should not maintain quotas against imports 4.Countries should declare export subsidies provided to particular firms, sectors, or industries

15 Chapter 15 of © 2007 Worth Publishers International Economics Feenstra/Taylor A Brief History of the World Trade Organization 5.Countries can temporarily raise tariffs for certain products. Article XIX is called the safeguard provision or the escape clause and is our focus in this chapter The importing country can temporarily raise a tariff when domestic producers are suffering due to import competition European governments strenuously objected to the US steel tariffs, and filed a complaint against the US with the WTO A panel at the WTO ruled in favor of the European countries, entitling them to retaliate by placing tariffs of their own on $2.2 billion worth of US exports This lead President Bush to remove the steel tariffs in December 2003

16 Chapter 16 of © 2007 Worth Publishers International Economics Feenstra/Taylor A Brief History of the World Trade Organization 6.Regional trade agreements are permitted under Articles XXIV of the GATT Free trade areas Customs unions

17 Chapter 17 of © 2007 Worth Publishers International Economics Feenstra/Taylor The Gains from Trade We will now demonstrate the gains from trade using Home demand and supply curves, together with the concepts of consumer and producer surplus Consumer and Producer Surplus Figure 8.1 (a) shows the Home demand curve D, consumers facing a price of P 1 A person buying unit D 2 is willing to pay P 2, but only has to pay of P 1 The individual obtains a surplus of (P 2 – P 1 ) from being able to purchase the good for less than their willingness to pay

18 Chapter 18 of © 2007 Worth Publishers International Economics Feenstra/Taylor The Gains from Trade Consumer and Producer Surplus For each unit before D 1, the consumers value exceeds the purchase price of P 1 Adding up the surplus obtained on each unit purchased, from zero to D 1, gives the total surplus The total satisfaction that consumers receive from the purchased quantity D 1, over and above the amount P 1 D 1 that they have paid Consumer surplus is then the shaded region between the demand curve and the market price, up to the total quantity purchased; D 1 in this case

19 Chapter 19 of © 2007 Worth Publishers International Economics Feenstra/Taylor The Gains from Trade D P1P1 Price D 2 D 1 Quantity Total Consumer surplus, CS P2P2 Surplus for consumer purchasing quantity D 2 The demand curve gives us the consumers value for each unit of the good. Given P 1, consumers will buy a total of D 1. A consumer who purchases D 2 has a value of P 2, but only has to pay P 1 – that gives surplus equal to (P 2 -P 1 ) Adding up all the individual surplus for each point on the demand curve gives us total consumer surplusthe area between the demand and the price paidup to the quantity sold Figure 8.1 (a)

20 Chapter 20 of © 2007 Worth Publishers International Economics Feenstra/Taylor The Gains from Trade Part (b) of Figure 8.1 illustrates producer surplus At the price of P 1, the industry will supply S 1 Remember that the supply curve represents a firms marginal cost of production The firm supplying unit S 0 could produce it with a marginal cost of P 0, but is able to sell it for P 1 This gives the firm a surplus of (P 1 – P 0 )

21 Chapter 21 of © 2007 Worth Publishers International Economics Feenstra/Taylor The Gains from Trade For each unit sold before S 1, the marginal cost to the firm is less than the sale price of P 1 If we add up all these individual surpluses obtained for each unit sold from zero to S 1, we get the total producer surplus (PS) Producer surplus is the area above the supply curve to the price received, up to the quantity sold We can also refer to PS as the return to fixed factors of production in the industry, and can loosely refer to it as profit.

22 Chapter 22 of © 2007 Worth Publishers International Economics Feenstra/Taylor The Gains from Trade S Price S 0 S 1 Quantity Total Producer surplus, PS P0P0 P1P1 Surplus for firm producing quantity S 0 Figure 8.1 (b) The supply curve gives us the consumers value for each unit of the good. Given P 1, producers will sell a total of S 1. A producer who sells S 0 has a MC of P 0, but gets P 1. That gives surplus equal to (P 1 -P 0 ) Adding up all the individual surpluses for each point on the supply curve gives us total producer surplusthe area between the supply and the price receivedup to the quantity sold.

23 Chapter 23 of © 2007 Worth Publishers International Economics Feenstra/Taylor The Gains from Trade Home Welfare Again we consider the world of two countries, Home and Foreign, with producers and consumers Total Home welfare can be measured by adding up consumer and producer surplus The greater the total surplus, the greater the total home welfare, the better off the country is We will compare the welfare in a Home in no- trade and the free trade situations

24 Chapter 24 of © 2007 Worth Publishers International Economics Feenstra/Taylor The Gains from Trade No-Trade In Figure 8.2 (a), the no trade equilibrium occurs at the autarky price of P A, where quantity demanded equals quantity supplied at Q 0 Consumer and producer surplus are shown as the areas defined before. Adding these gives total surplus for Home before trade

25 Chapter 25 of © 2007 Worth Publishers International Economics Feenstra/Taylor The Gains from Trade A PAPA D Price S Q 0 Quantity CS PS No-trade equilibrium (a) No-Trade Figure 8.2

26 Chapter 26 of © 2007 Worth Publishers International Economics Feenstra/Taylor The Gains from Trade Free Trade for a Small Country Suppose Home can now engage in trade in figure 8.2 (b) The world price P W is determined by the supply and demand in the world market Suppose Home is a small country Price taker in the world market Faced a fixed price at P W Assume P W is below the Home no-trade price P A At the lower price, Home quantity demanded will increase to D 1 and Home quantity supplied will decrease to S 1 Home will be an importer of the product at the world price

27 Chapter 27 of © 2007 Worth Publishers International Economics Feenstra/Taylor The Gains from Trade PAPWPAPW Price S 1 D 1 Quantity S D Figure 8.2 At the free trade price of P W, Home supply will fall to S 1 and Home demand will rise to D 1. Imports will make up for the excess demand and will equal (D 1 – S 1 ) Imports (b) Free Trade

28 Chapter 28 of © 2007 Worth Publishers International Economics Feenstra/Taylor The Gains from Trade Consumers gain more than the producers lose indicating total Home welfare increased By looking at the changes in surplus we see: Rise in consumer surplus+(b+d) Fall in producer surplus-b Net effect on Home welfared d is a measure of the gains from trade for the importing country due to free trade We can measure this gain directly using the formula for the area of the triangle = ½ bh Welfare increase = ½ (M 1 )(P A -P W )

29 Chapter 29 of © 2007 Worth Publishers International Economics Feenstra/Taylor The Gains from Trade Gains from Trade We can now measure the welfare effects for producers and consumers under free trade Since price has fallen under trade, we would expect this to be good for consumers and therefore consumer surplus to increase Consumer surplus increases by b+d in Figure 8.2 (b) Similarly, a lower price is worse for producers so we would expect producer surplus to fall Producer surplus falls by b in Figure 8.2 (b)

30 Chapter 30 of © 2007 Worth Publishers International Economics Feenstra/Taylor PAPWPAPW The Gains from Trade Price S 1 D 1 Quantity S a b c D Figure 8.2 At lower world price, consumer surplus increases to a+b+d an increase of b+d from no-trade At lower world price, producer surplus falls to c a decrease of b from no-trade Imports, M1 Gain in trade is triangle d with area equal to ½(M 1 )(P A -P W ) d (b) Free Trade

31 Chapter 31 of © 2007 Worth Publishers International Economics Feenstra/Taylor The Gains from Trade Home Import Demand Curve We can now derive the import demand curve, shown in Figure 8.3 The relationship between the world price of a good and the quantity of imports demanded by Home consumers At the no-trade equilibrium, there are zero imports This is shown as point A in panel (b) At the world price of P W, the quantity demanded is greater than quantity supplied, and we import M 1 This is point B in panel (b) Joining A and B gives import demand curve M

32 Chapter 32 of © 2007 Worth Publishers International Economics Feenstra/Taylor B The Gains from Trade D PAPWPAPW Price S S 1 Q 0 D 1 Quantity Price M 1 Imports Import demand curve, M A A' No-trade equilibrium Imports, M 1 Each point on the import demand curve is a point that corresponds to Home imports at a given Home price Figure 8.3 (a) (b)

33 Chapter 33 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Small Country We can also use the supply/demand framework to show what happens when a small country imposes a tariff Remember a small country is one where its imports does not have any effect on world price This means the price charged to Home consumers will increase by the amount of the tariff

34 Chapter 34 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Small Country Free Trade for a Small Country We start with the free trade equilibrium for the Home country in figure 8.4 The Foreign export supply curve X* is horizontal at the world price P W This means that Home can import an amount at the price P W without having an impact on that price In free trade equilibrium, home demand is D 1, Home supply is S 1, and imports are M 1

35 Chapter 35 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Small Country Effect of the Tariff With an import tariff of t dollars, the export supply curve facing Home shifts up by exactly the amount of the tariff The new export supply curve shifts up to X*+t The new intersection now occurs at the price of P W +t and the import quantity of M 2 The import tariff has reduced the amount imported, from M 1 under free trade to M 2 under the tariff, due to the higher price

36 Chapter 36 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Small Country Effect of the Tariff At the higher import price, the quantity demanded at Home falls and the quantity supplied at Home rises, from S 1 to S 2 However, as firms increase the quantity produced, the marginal costs of production rise The home supply curve reflects marginal costs so the Home price rises along S until firms are supplying quantity S 2 at a MC just equal to the new price, P W +t The domestic price will equal the import price.

37 Chapter 37 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Small Country Effect of the Tariff Home price rises to P W +t thereby decreasing the quantity of Home demand Higher prices increase the quantity of Home supply Less excess demand therefore imports fall Foreign exporters still receive the net of tariff price, P W These changes affect producer and consumer surplus, and overall Home welfare

38 Chapter 38 of © 2007 Worth Publishers International Economics Feenstra/Taylor Quantity M1M1 Imports Foreign export supply, X* B Import Tariffs for a Small Country M Price M2M2 C Figure 8.4 A D X*+t P W +t Price S No-trade equilibrium M2M2 Home price rises by the amount of the tariff. Home supply increases and Home demand decreases Imports fall to M 2 PWPW S 1 D 1 S 2 D 2

39 Chapter 39 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Small Country Effect of the Tariff on Consumer Surplus With the tariff, consumers now pay the higher price, P W +t, and their surplus is the area under the demand curve and above the higher price, P W +t The fall in consumer surplus due to the tariff is the area in-between the two prices and to the left of Home demand, (a+b+c+d) in panel (a.1) of figure 8.5 This area is the amount that consumers lose due to the higher price caused by the tariff

40 Chapter 40 of © 2007 Worth Publishers International Economics Feenstra/Taylor P W +t P W Import Tariffs for a Small Country A D Price S S 1 S 2 D 2 D 1 Quantity No-trade equilibrium M2M2 Lost consumer surplus due to the higher price with the tariff is equal to the shaded area (a+b+c+d) a b d c Figure 8.5 (a.1)

41 Chapter 41 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Small Country Effect of the Tariff on Producer Surplus With the tariff, producer surplus is the area above the supply and below the higher price, P W +t Since the tariff increased Home price, firms can sell more goods, and producer surplus increases This area, a in figure 8.5 (a.2), is the amount that Home firms gain due to the higher price caused by the tariff. Increases in producer surplus can benefit Home workers but at the expense of Home consumers

42 Chapter 42 of © 2007 Worth Publishers International Economics Feenstra/Taylor P W +t P W Import Tariffs for a Small Country A D Price S S 1 S 2 D 2 D 1 Quantity No-trade equilibrium M2M2 The gain in producer surplus due to the higher price with the tariff is equal to the shaded area (a) a b d c Figure 8.5 (a.2)

43 Chapter 43 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Small Country Effect of the Tariff on Government Revenue In addition to the tariffs impact on consumers and producers, it also affects government revenue The amount of revenue collected is the tariff t times the quantity of imports (D 2 – S 2 ) In figure 8.5 panel (a.3), the revenue is shown by area c The collection of revenue is a gain for the government in the importing country

44 Chapter 44 of © 2007 Worth Publishers International Economics Feenstra/Taylor P W +t P W Import Tariffs for a Small Country A D Price S S 1 S 2 D 2 D 1 Quantity No-trade equilibrium M2M2 The gain in government revenue due to the tariff is equal to the shaded area (c) This equals the tariff, t, times the quantity of imports, M 2 a b d c Figure 8.5 (a.3)

45 Chapter 45 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Small Country Overall Effect of the Tariff on Welfare We can now summarize the total impact of the tariff on the welfare of the Home importing country by adding the gains and losses for each party Note, we do not care whether the consumers facing higher prices are rich or poor, and do not care whether the specific factors in the industry earn a lot or a little Under this approach, transferring one dollar from consumer to producer surplus will have no impact on overall welfare We are simply evaluating the efficiency of the tariff

46 Chapter 46 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Small Country Overall Effect of the Tariff on Welfare The overall impact of the tariff in the small country can be summarized as follows: Fall in consumer surplus-(a+b+c+d) Rise in producer surplus+a Rise in government revenue+c Net effect on Home welfare-(b+d) The areas b and d in figure 8.5 (a) correspond to the triangle (b+d) in figure 8.5 (b) and is the net welfare loss We refer to this area as a deadweight lossit is not offset by a gain elsewhere in the economy

47 Chapter 47 of © 2007 Worth Publishers International Economics Feenstra/Taylor P W +t P W Import Tariffs for a Small Country A D Price S S 1 S 2 D 2 D 1 Quantity No-trade equilibrium M2M2 The deadweight loss is the loss to Home that is not offset by a corresponding gain a b d c Figure 8.5 (a) a is a transfer from consumers to producers c is a transfer from consumers to government (b+d) is deadweight loss losses not offset by other gains

48 Chapter 48 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Small Country Figure 8.5 (b) M1M1 Imports X* M Price M2M2 X*+ t C Dead weight loss due to tariff, b+d

49 Chapter 49 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Small Country Overall Effect of the Tariff on Welfare The area a is effectively a transfer from consumers to producers via the higher domestic prices induced by the tariff The area c, the gain in government revenue, is a transfer from consumers to the government The deadweight loss, (b+d), is measured by the two triangles b and d The two triangles can each be given a precise interpretation

50 Chapter 50 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Small Country Production Loss The base of b is the net increase in Home supply due to the tariff, from S1 to S2 The height of this triangle is the increase in marginal costs due to the increase in supply The fact that marginal costs are greater than world price means that this country is producing the extra supply inefficiently Fewer resources would be used if imported rather than produced at home The area of b is the production loss or efficiency lossdue to producing at marginal costs above world price

51 Chapter 51 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Small Country Consumption Loss The triangle d also has a precise definition Due to the tariff, the price increase from, P W to P W +t reduces quantity consumed at Home from D 1 to D 2 The area of the triangle can be interpreted as the drop in consumer surplus for those individuals who are no longer able to consume the units from D 1 to D 2 because of the higher price We refer to this drop in consumer surplus as the consumption loss for the economy

52 Chapter 52 of © 2007 Worth Publishers International Economics Feenstra/Taylor Why are Tariffs Used? Finding that tariffs always lead to deadweight losses for small countries explains why most economists are opposed to them Why then do so many countries use tariffs? One idea is that developing countries do not have any other source of revenue Import tariffs are easy to collect because every country has customs agents at major ports checking the goods crossing the borders However, to the extent that developing countries recognize that tariffs have a higher deadweight loss, we would expect that over time they will shift away from such easy to collect taxes

53 Chapter 53 of © 2007 Worth Publishers International Economics Feenstra/Taylor Why are Tariffs Used? Why then do so many countries use tariffs? A second reason is politics If the government cares more about producer surplus than consumer surplus, it might decide to use the tariff despite the deadweight loss it incurs The benefits to producers (and their workers) are typically more concentrated on specific firms and states than the costs to consumers which are spread nation-wide

54 Chapter SIDE BAR 54 of © 2007 Worth Publishers International Economics Feenstra/Taylor Globalization and Developing Countries Developing countries rely on easy to collect tariffs over hard to collect income and value-added taxes As globalization expands, we would expect these countries to move away from tariffs to the more hard to collect revenues According to one research study, the ratio of tax revenue to GDP obtained from easy to collect taxes fell by about 20% in developing countries between 1980s and 1990s

55 Chapter SIDE BAR 55 of © 2007 Worth Publishers International Economics Feenstra/Taylor Globalization and Developing Countries At the same time the ratio of tax revenue to GDP from hard to collect revenue rose by 9% in the developing countries The loss from easy to collect taxes was not enough to make up for the gain from hard to collect taxes It is harder to improve the performance of hard to collect taxes than it is to shift away from the easy to collect taxes for low income countries High and middle income countries were able to obtain a net increase in tax revenue from this process

56 Chapter APPLICATION 56 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel We can use our small country model from above to calculate a rough estimate of how costly these tariffs were in terms of welfare We will estimate the deadweight loss due to the US steel tariff in place from March 2002 to December 2003 President Bush requested that the US International Trade Commission (ITC) initiate a Section 201 investigation into the steel industry

57 Chapter APPLICATION 57 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel The ITC determined that the conditions were met and recommended that tariffs be put in place to protect the US steel industry The tariffs varied across products, ranging from 10 to 20%shown in Table 8.1then falling over time to be eliminated after 4 years The ITC decision showed that the losses from rising imports and falling prices met the conditions of serious injury

58 Chapter APPLICATION 58 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel President Bush took the recommendation of the ITC but applied even higher tariffs, ranging from 8% to 30% Knowing the US trading partners would be upset by this, President Bush exempted some countries from the tariffs These included Canada, Mexico, Jordan, and Israel, which all have free trade agreements with the US and 100 small developing countries that were exporting only a very small amount of steel to the US

59 Chapter APPLICATION 59 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel Table 8.1

60 Chapter APPLICATION 60 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel Deadweight Loss due to the Steel Tariff We need to estimate the areas of triangle b+d we found in figure 8.5 (b) The base is the change in imports, ΔM, and the height is the increase in domestic price, ΔP = t. Deadweight loss then equals, DWL = ½ t ΔM It is convenient to measure the deadweight loss relative to the value of imports, which is P W *M We will also use the percentage tariff, t/P W, and the percentage change in the quantity of imports, %ΔM = ΔM/M

61 Chapter APPLICATION 61 of © 2007 Worth Publishers International Economics Feenstra/Taylor PWPW P W +t U.S. Tariffs on Steel Price M 2 M 1 Imports M Deadweight loss due to the tariff, b+d c Figure 8.5 (b) ΔMΔM t We can measure DWL with the area of the triangle b+d from figure 8.5 (b) DWL = ½ t ΔM

62 Chapter APPLICATION 62 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel Using these definitions, the deadweight loss relative to the value of imports can be rewritten as: The most commonly used products had a tariff of 30%, so the percentage increase in the price is t/P W = 0.3, leading to %ΔM = 0.3

63 Chapter APPLICATION 63 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel This leads to a DWL of The value of steel imports affected by the tariff was about $4.7 billion prior to March 2002 and $3.5 billion after March 2002 Average imports over the two years was then $4.1 billion

64 Chapter APPLICATION 64 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel Applying the DWL of 4.5% to the average import value of $4.1 billion gives the dollar magnitude of deadweight loss equal to $185 million This deadweight loss reflects the net annual loss to the US from applying the tariff A steel worker might think this is ok in order to protect jobs, but consumers would probably not agree

65 Chapter APPLICATION 65 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel Response of the European Countries The tariffs on steel most heavily affected Europe, Japan, and South Korea, along with some developing countries The countries in the European Union therefore took action by bringing the case to the WTO The WTO has a formal dispute settlement procedure, under which countries can bring complaint and have it evaluated The WTO ruled that the US had failed to prove its steel industry had been harmed by imports and therefore did not have the right to impose the tariffs

66 Chapter APPLICATION 66 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel Response of the European Countries Even if we accept that there might be an argument on equity or fairness grounds for temporarily protecting an industry facing import competition, it is hard to argue that such protection should occur due to a change in exchange rates The appreciation of the dollar lowered prices for all other imports too, so many industries faced competition Why should the steel industry be protected and not the others?

67 Chapter APPLICATION 67 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel Response of the European Countries The WTO ruling entitled the European Union and other countries to retaliate against the US by imposing tariffs of their own against US exports The EU quickly began to draw up a list of products and naturally picked products that would have the greatest impact on the US The threat of tariffs led President Bush to reconsider the US tariffs on steel, and on December 5, 2003, he announced that they would be suspended You can see how these chain of events could lead to a tariff war

68 Chapter HEADLINES 68 of © 2007 Worth Publishers International Economics Feenstra/Taylor Europes Little List How are steel and orange juice related? When the WTO ruled that the US tariffs on steel violated international trade law, it allowed the European Union to implement $2.2 billion in retaliatory taxes on US exports On the list were oranges and orange juice, big exports of Florida, a major swing state with Jeb Bush as Governorthe Presidents brother Michigan and Wisconsin apples and California farm products were also on the list

69 Chapter HEADLINES 69 of © 2007 Worth Publishers International Economics Feenstra/Taylor Europes Little List Another group targeted were makers of industrial farm equipment like John Deere and Caterpillarboth based in the key electoral state of Illinois Toilet paper might seem like an odd item for the hit list, but is part of the paper industry, which was targeted affecting many other important states

70 Chapter 70 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Large Country Under the small country assumption that we have used so far, the importing country is always harmed due to the tariff Small country is a world price taker If we consider a large enough importing country or a large country, however, then we might expect that its tariff will change the world price Their imports are large enough that they can affect world price with a change in their imports

71 Chapter 71 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Large Country Foreign Export Supply If the Home country is large, then the Foreign export supply curve X* is no longer horizontal at the world price P W We need to derive the foreign export supply curve using the Foreign market demand and supply curves In panel (a) of Figure 8.6, we show the Foreign demand curve D* and supply curve S*, giving price of P A * at A* At this point, Foreign exports are zero

72 Chapter 72 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Large Country Foreign Export Supply Now suppose the world price is P W above P A * At the higher price, Foreign quantity demanded is lower at D 1 *, but quantity supplied by foreign firms is higher at S 1 * Foreign excess supply of X 1 * = S 1 * - D 1 *, will be exported at the price of P W at point B* Connecting A* and B* gives the upward sloping Foreign export supply curve, X* Combining with Home import demand, M, we get an equilibrium at P W and X 1 *

73 Chapter 73 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Large Country Price Quantity Exports D* S* Home import demand, M D1*D1* S1*S1* A* A*' PA*PA* PWPW B* X1*X1* Foreign exports, X 1 * Foreign export supply, X* World price increases to P W, increasing exports to X 1 * Figure 8.6 This gives us our Foreign export supply curve for the large country At the world price, P A *, exports are zero at A* (a) Foreign Mkt (b) World Mkt

74 Chapter 74 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Large Country Effect of the Tariff Figure 8.7 we show the effect when Home applies a tariff of t dollars on imports The tariff increases the cost to Foreign producers of supplying to the Home market Foreign export supply curve shifts up by exactly the amount of the tariff, shifting from X* to X*+t The new supply crosses demand at C, giving a new Home price However, notice that the price that Foreign producers receive, P*, ends up below the original free trade price

75 Chapter 75 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Large Country Effect of the Tariff The price Home pays for its imports P*+t rises by less than the amount of the tariff, t, as compared to the initial world price, P W This is because the price received by foreign exporters, P*, has fallen as compared to the initial world price, P W Foreign producers are essentially absorbing a part of the tariff, by lowering their price from P W to P* The tariff drives a wedge between what Home consumers pay and what foreign producers receive, with the difference, t, going to the Home government

76 Chapter 76 of © 2007 Worth Publishers International Economics Feenstra/Taylor M2M2 M1M1 Import Tariffs for a Large Country A Price P*+t S Price Imports D S 1 S 2 D 2 D 1 Quantity M 2 M 1 M X*+t (a) Home market X* B* C C* No-trade equilibrium t (b) Foreign market t t Figure 8.7 (without welfare effects) PWPW P*

77 Chapter 77 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Large Country Terms of Trade Remember terms of trade is the ratio of export prices to import prices In order to measure terms of trade, we want to use the net-of-tariff import price, P* Since P* is lower than P W, it follows that the Home terms of trade has increased We might expect, therefore, that the Home country gains from the tariff We need to analyze the impact of the tariff on Home consumers, producers, and government

78 Chapter 78 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Large Country Home Welfare The higher Home price, makes consumers worse off by lowering consumer surplus, shown by (a+b+c+d) in figure 8.7 Home firms are better off with the higher price and increased surplus, a Revenue collected from the tariff equals the amount of the tariff, t, times the new amount of imports, M 2, giving total revenue of (c+e) Summing all the gains and losses, we obtain the overall impact of the tariff in the large country

79 Chapter 79 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Large Country Home Welfare Fall in consumer surplus-(a+b+c+d) Rise in producer surplus+a Rise in government revenue+(c + e) Net effect on Home welfaree – (b+d) + (e) The triangle (b+d) is the deadweight loss due to the tariff. But notice, there is a source of gain, e, that offsets part of the loss If e > (b+d), then Home is better off If e < (b+d), then Home is worse off

80 Chapter 80 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Large Country A Price a c P*+t P W P* S b d Price Imports e D S 1 S 2 D 2 D 1 Quantity M 2 M 1 M X*+t e X* B* C C* b+d No-trade equilibrium t (a) Home market (b) Foreign market Figure 8.7 (with welfare effects) If the gain of e is greater than the loss of (b+d), Home gains

81 Chapter 81 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Large Country Home Welfare We see that a large importer might gain due to the application of a tariff However, for the large country, any net gain due to the tariff comes at the expense of the Foreign exporters Although Home might gain from the tariff, Foreign definitely loses

82 Chapter 82 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Large Country Foreign and World Welfare The Foreign loss, measured by (e+f) also in figure 8.7, is the loss in Foreign producer surplus from selling fewer goods to Home at a lower price The area e is the terms of trade gain for Home but an equivalent terms of trade loss for Foreign Additionally, there is an extra deadweight loss in Foreign of f, giving a combined total greater than the benefits to Home Therefore, it is sometimes called the beggar thy neighbor tariff

83 Chapter 83 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Large Country A Price a c P*+t P W P* S b d Price Imports e D S 1 S 2 D 2 D 1 Quantity M 2 M 1 M X*+t e X* B* C C* b+d No-trade equilibrium t (a) Home market (b) Foreign market Figure 8.7 (with welfare effects) Foreign loses (e+f) as loss of Foreign producer surplus, from selling fewer goods at a lower price f

84 Chapter 84 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Tariffs for a Large Country Foreign and World Welfare Adding together the change in Home and Foreign welfare, e cancels out leaving a net loss to world welfare of -(b+d+f) We saw this triangle in panel (b) of figure 8.7, which is the deadweight loss for the world The fact that the large country tariff leads to a world deadweight loss, is another reason that most economists oppose the use of tariffs

85 Chapter APPLICATION 85 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel Once Again Returning to the US tariff on steel, we can reevaluate the effect on US welfare in the large country case If the US is a large enough importer of steel, then the foreign export price will fall and the US import price will rise by less than the tariff It is possible that the US gained from the tariff

86 Chapter APPLICATION 86 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel Once Again Optimal Tariff We can compute the deadweight loss (area b+d) and the terms of trade gain (area e) for each imported steel product This would give us the information to see if the US gained from the steel tariffs Rather than do all these calculations, however, we can use the concept of the optimal tariff This is the tariff that leads to the maximum increase in welfare for the importing country We have shown that for a small tariff, a large country can gain. But if the tariff is too large, the country will still lose

87 Chapter APPLICATION 87 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel Once Again Optimal Tariff Figure 8.8 graphs Home welfare against the level of the tariff Free trade is at point B where the tariff is zero Starting at B, increasing the tariff can increase the importers welfare, to a point If the tariff is too large, then welfare will fall below the free trade level of welfare For example, a prohibitive tariff is one so high there are no importsthis is point A Given this, you can see that the highest point of welfare for the importing country is shown by C

88 Chapter APPLICATION 88 of © 2007 Worth Publishers International Economics Feenstra/Taylor Free Trade Importers Welfare No Trade U.S. Tariffs on Steel Once Again B A C Terms of trade gain exceeds deadweight loss Terms of trade gain is less than deadweight loss B' Optimal Tariff Prohibitive Tariff Tariff The Optimal tariff maximizes the Importers welfare, Point C Too high of a tariff will decrease importers welfare and can increase to the point where there is no trade Figure 8.8

89 Chapter APPLICATION 89 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel Once Again Optimal Tariff Formula The optimal tariff depends on the elasticity of Foreign export supply, E X * This is the percentage change in the quantity exported in response to a percent change in the world price of the export If the export supply curve is very steep, there is little response in quantity suppliedinelasticE X * is low If the export supply curve is very flat, there is a large response in quantity suppliedelasticE X * is high

90 Chapter APPLICATION 90 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel Once Again Optimal Tariff Formula Optimal Tariff = 1/E X * For a small importing country, the elasticity of Foreign export supply is infinite, and so the optimal tariff is zero As the elasticity of Foreign export supply decreases, Foreign export supply curve is steeper, the optimal tariff is higher With a steep Foreign export supply curve, Foreign exporters will lower their price more in response to the tariff

91 Chapter APPLICATION 91 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel Once Again Optimal Tariffs for Steel If we apply this formula to the US steel tariffs, we can see how the tariffs applied compare to the theoretical optimal tariff Table 8.2 shows various steel products along with their respective elasticities of export supply to the US We can compare the actual tariff to the optimal tariff to see where there were gains and where there were losses from the tariffs

92 Chapter APPLICATION 92 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel Once Again For alloy steel flat-rolled products, its actual tariff was 30%, which is far below its optimal tariff The terms of trade gain for that product was higher than the deadweight loss US welfare is above its free trade level In summary, two products had terms of trade greater than the deadweight loss, but the third had a larger deadweight loss The first two illustrate the large country case, while the third illustrates the small country case

93 Chapter APPLICATION 93 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel Once Again Table 8.2

94 Chapter APPLICATION 94 of © 2007 Worth Publishers International Economics Feenstra/Taylor U.S. Tariffs on Steel Once Again Even if there was an overall terms of trade gain for the US when adding up across all steel products, that gain would be at the expense of the European countries and other steel exporters By allowing exporting countries to retaliate with tariffs, the WTO prevents importers from using optimal tariffs to their own advantage

95 Chapter 95 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas On January 1, 2005 China was poised to become the worlds largest exporter of textiles and apparel On that date, the Multifibre Arrangement (MFA) was abolished Under the MFA, import quotas restricted the amount of nearly every textile and apparel product that was imported to Canada, Europe, and the US The quotas were to protect their own domestic firms producing those products With the end of the MFA, China was ready to enjoy greatly increased imports

96 Chapter 96 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas The threat of import competition from China led the US and Europe to negotiate new quotas with China These are not the first quotas Europe had a quota on the imports of bananas that allowed for a greater number of bananas to enter from its former colonies in Africa than from Latin America (now a tariff) In the next section, we explain how quotas affect the importing and exporting countries, and examine the differences between quotas and tariffs

97 Chapter HEADLINES 97 of © 2007 Worth Publishers International Economics Feenstra/Taylor Europe Reaches Deal on Banana Imports The European Union changed their trade barriers to allow banana imports from countries that were once European colonies and to restrict imports from other countries, primarily in Latin America The proposal was to implement one import tariff but no quotas on bananas except for former French, British, and Portuguese colonies which will continue to enjoy duty- free access

98 Chapter HEADLINES 98 of © 2007 Worth Publishers International Economics Feenstra/Taylor Europe Reaches Deal on Banana Imports This change replaces the prior trade policy that was a mixture of tariffs and quotas, but is still higher than the Latin American countries are content with The European countries are split over what to do about these policies. Some want to protect their own growers interests and others want to keep prices low for consumers

99 Chapter HEADLINES 99 of © 2007 Worth Publishers International Economics Feenstra/Taylor Sweet Opportunity The current US sugar program guarantees that American sugar producers receive a set price for their product If they are not able to sell all their sugar at the break-even price after accounting for their loans, they can sell the excess to the US Department of Agriculture To keep from storing a large stock of sugar, the US regulates supply by imposing import quotas on sugar

100 Chapter HEADLINES 100 of © 2007 Worth Publishers International Economics Feenstra/Taylor Sweet Opportunity But, the US price of sugar has been two to three times higher than the world price of sugar for about 25 years The longer the protection holds, the more inefficient the US producers become, and the more powerful they become as a special interest group Given that the current world price of sugar has increased and put foreign producers on par with the US, there is an opportunity to do away with the sugar program

101 Chapter 101 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas Import Quota in a Small Country Free Trade Equilibrium Figure 8.9 (a) shows the free trade equilibrium at a world price of P W, home quantity demanded of D 1, quantity supplied of S 1, with imports of M 1 as before Assuming the country is small, meaning the world price is not affected by the import quota, the Foreign export supply curve, X*, is horizontal at P W We can see the free trade amount of imports in panel (b) as well: M 1 at P W

102 Chapter 102 of © 2007 Worth Publishers International Economics Feenstra/Taylor B M1M1 M1M1 A Import Quotas S 1 D 1 Quantity D Price S Imports Home import demand, M PWPW Foreign export supply, X* No-trade equilibrium (a) Home market (b) Import market Figure 8.9 (without quota) At P W, Home Supplies S 1, Demands D 1, and Imports M 1 In free trade equilibrium for a small country, Foreign faces a horizontal export supply curve, X*, at the world price P W

103 Chapter 103 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas Effect of the Quota Suppose the import quota of M 2 { "@context": "http://schema.org", "@type": "ImageObject", "contentUrl": "http://images.slideplayer.com/3/1389407/slides/slide_102.jpg", "name": "Chapter 103 of 136 8 © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas Effect of the Quota Suppose the import quota of M 2

104 Chapter 104 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas Effect of the Tariff The import quota leads to an increase in the Home price, and a reduction in Home imports, just like the tariff We can see what the equivalent tariff, the tariff that would be set to give the same quantity and price as the quota, would be: t = P 2 – P W For every level of import quota, there is an equivalent import tariff

105 Chapter 105 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas Effect on Welfare The rise in price from the quota leads to a fall in consumer surplus: (a+b+c+d) The increase in price facing Home producers leads to a gain in producer surplus: a What changes with the quota is the area c which was government revenue under the tariff With a quota, whoever is actually importing the good will be able to earn c, the difference between the world price and the higher Home price times the imports sold in the Home market

106 Chapter 106 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas Figure 8.9 (with quota) B A Quantity D Price S Imports M1M1 Foreign export supply, X* Home import demand, M P2P2 C No-trade equilibrium c a d b+d c b (a) Home market (b) Import market Foreign export supply with quota With the Quota, the Foreign export supply becomes vertical at the quota quantity The new Export Supply curve crosses the Import Demand curve at a new price and quantity of imports At the new higher price P 2, Home Supply increases to S 2, Demand decreases to D 2 and imports fall to M 2 Always have a deadweight loss of (b+d) like the tariff Consumers loses surplus of (a+b+c+d), producers gain (a). Welfare of Home depends on what happens to (c). PWPW S1S1 S2S2 D2D2 D1D1 M2M2

107 Chapter 107 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas The difference between these two prices is the rent associated with the quota Area c represents the total quota rents There are four possible ways these rents can be allocated 1.Giving the Quota to Home Firms Quota licenses can be given to Home firms Permits to import the quantity allowed under the quota system The net effects on Home welfare due to the quota are then as follows:

108 Chapter 108 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas Fall in consumer surplus-(a+b+c+d) Rise in producer surplus+a Quota rents earned at Home+c Net effect on Home welfare:-(b+d) This is the same loss we saw with a tariff (b+d) is still a deadweight loss associated with the quota

109 Chapter 109 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas 2.Rent Seeking Because of the gains associated with owning a quota license, firms have an incentive to engage in inefficient activities in order to obtain them How licenses are allocated matters a.If licenses are allocated in proportion to each firms production, Home firms will likely produce more than they can sell just to obtain the import licenses for the following year b.Firms might engage in bribery or other lobbying activities to obtain the licenses

110 Chapter 110 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas Rent Seeking Some suggest that the waste of resources devoted to rent seeking could be as large as the value of the rents themselves – waste c If rent seeking occurs, welfare loss of quota is: Fall in consumer surplus-(a+b+c+d) Rise in producer surplus+a Net effect on Home welfare:-(b+c+d) This loss is larger than a tariff It is thought rent seeking is worse in developing countries

111 Chapter 111 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas 3.Auctioning the Quota The government of the importing country to auction off the quota licenses In a well-organized, competitive auction, the revenue collected should exactly equal the value of the rents Fall in consumer surplus-(a+b+c+d) Rise in producer surplus+a Auction revenue earned at Home+c Net effect on Home welfare:-(b+d) This is the same loss as the tariff

112 Chapter SIDE BAR 112 of © 2007 Worth Publishers International Economics Feenstra/Taylor Auctioning Import Quotas in Australia and New Zealand During the 1980s, Australia and New Zealand both auctioned the quota licenses to import specific goods Table 8.3 shows the value of imports covered by quotas curing 1981–1987 In 1988, New Zealand announced plans to phase out import quotas as part of a liberalization of trade, and all quota licenses were eliminated by 1992

113 Chapter SIDE BAR 113 of © 2007 Worth Publishers International Economics Feenstra/Taylor Auctioning Import Quotas in Australia and New Zealand Table 8.3 also shows the value of bids for the quota licenses These are estimates of rents If we take the ratio of the value of bids to the value of imports covered by the quota, we obtain an estimate of the tariff equivalent to the quota These are shown in the final column of 8.3 Since there was no penalty from not following through, some firms decided not to purchase the licenses after all

114 Chapter SIDE BAR 114 of © 2007 Worth Publishers International Economics Feenstra/Taylor Auctioning Import Quotas in Australia and New Zealand Table 8.3

115 Chapter SIDE BAR 115 of © 2007 Worth Publishers International Economics Feenstra/Taylor Auctioning Import Quotas in Australia and New Zealand The government therefore did not collect all the winning bids as revenue For those that did buy their licenses, they could be resold and some were at much higher prices This makes it appear that the government was not collecting all of the rents in area c

116 Chapter 116 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas 4.Voluntary Export Restraint The importing country can give authority for implementing the quota to the exporting government This is often called a voluntary export restraint (VER) or a voluntary restraint agreement (VRA) In the 1980s the US used this type of arrangement to restrict imports of Japanese automobiles The Japanese government told each Japanese firm how much it could export to the US

117 Chapter 117 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas With VERs, quota rents are earned by foreign producers, making Home welfare: Fall in consumer surplus-(a+b+c+d) Rise in producer surplus+a Net effect on Home welfare:-(b+c+d) This is of course higher than with a tariff Why would we do this? It is typically politicalthe exporting country is less likely to retaliate since they gain the area c This can often avoid a tariff or quota war

118 Chapter 118 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas Costs of Import Quotas in the US Table 8.4 presents some estimates of home deadweight losses and quota rents for some major US quotas In all cases except Dairy, the rents were earned by Foreign exporters Adding up the costs in the table, the total US deadweight loss due to these quotas ranged from $8–$12 billion annually Quota rents transferred another $7–$17 billion to foreigners Some, but not all, of these costs are relevant today since many of the quotas are no longer in place

119 Chapter 119 of © 2007 Worth Publishers International Economics Feenstra/Taylor Import Quotas Table 8.4

120 Chapter APPLICATION 120 of © 2007 Worth Publishers International Economics Feenstra/Taylor China and the Multifibre Arrangement One of the principles of GATT was that countries should not use quotas to restrict imports The MFA was a major exception to that which allowed the industrialized countries to restrict imports of textile and apparel products from the developing countries Organized under GATT, importing countries could join the MFA and arrange quotas bilaterally or unilaterally

121 Chapter APPLICATION 121 of © 2007 Worth Publishers International Economics Feenstra/Taylor China and the Multifibre Arrangement While the amount of the quotas was occasionally revised upward, they did not keep up with the increasing ability of new supplying countries to sell Under the Uruguay round of WTO, developing countries were able to negotiate an end to this system of import quotas. Given that China was a large supplier of textiles, the expiration of the MFA meant that China could win big Some developing countries and large producers in importing countries were concerned with the potential of Chinese exports on their economies

122 Chapter APPLICATION 122 of © 2007 Worth Publishers International Economics Feenstra/Taylor China and the Multifibre Arrangement Growth in Exports from China Immediately after January 1, 2005, exports of textiles and apparel from China grew rapidly In 2005, Chinas textile and apparel imports to the US rose by more than 40% compared to 2004 Figure 8.10 (a) shows the change in the value of exports of textiles and apparel from different countries. Note China The increases from China came at the expense of some higher-cost exporters, some of whose exports to the US declined by 10 to 20%

123 Chapter APPLICATION 123 of © 2007 Worth Publishers International Economics Feenstra/Taylor China and the Multifibre Arrangement Figure 8.10

124 Chapter APPLICATION 124 of © 2007 Worth Publishers International Economics Feenstra/Taylor China and the Multifibre Arrangement Panel (b) of Figure 8.10 shows the percentage change in the prices of textiles and apparel products from each country, depending on whether the products were subject to the MFA quota before January 1, 2005 or not China had the largest drop in the prices from 2004 to 2005 Many other countries had a substantial fall in their prices due to the end of the MFA quota

125 Chapter APPLICATION 125 of © 2007 Worth Publishers International Economics Feenstra/Taylor China and the Multifibre Arrangement Figure 8.10

126 Chapter APPLICATION 126 of © 2007 Worth Publishers International Economics Feenstra/Taylor China and the Multifibre Arrangement Welfare Cost of the MFA Given the drop in prices in 2005, it is possible to estimate the welfare loss due to the MFA Quota rents were earned by foreign exporting firms, giving a welfare loss to Home of area (b+c+d) shown in Figure 8.9 previously Using the price drops from Figure 8.10 above, (b+c+d) for the US is estimated at $6.5 to $16.2 billion in 2005 from the MFA Averaging out all losses and dividing among households gives an estimate of $100 per household, or 7% of total annual spending on apparel

127 Chapter APPLICATION 127 of © 2007 Worth Publishers International Economics Feenstra/Taylor China and the Multifibre Arrangement Import Quality There was also an interesting pattern to the price drops: the price dropped the most for the lowest priced items An inexpensive T-shirt had a greater drop in price than a more expensively priced item US demand shifted towards the lower-priced items imported from China: there was quality downgrading in the exports from China When a quota like the MFA is applied, there is an effect on quality

128 Chapter APPLICATION 128 of © 2007 Worth Publishers International Economics Feenstra/Taylor China and the Multifibre Arrangement Import Quality Remember that quotas are set on the quantity, not the quality of items that are imported This means that exporting countries have an incentive to upgrade the quality of the product Selling a higher value good for the same quantity will still meet the quota limit but will bring more money back home MFAs bring quality upgrading in the exports Similarly, when the MFA is removed, you will see quality downgrading

129 Chapter APPLICATION 129 of © 2007 Worth Publishers International Economics Feenstra/Taylor China and the Multifibre Arrangement Reaction of the United States and Europe The EU threatened to impose new quotas on Chinese exports In response, China agreed on June 11, 2005 to voluntarily restrict exports limiting the growth of textile exports to about 10% per year through the end of 2008 The US had the ability to negotiate a new system of quotas since China had joined the WTO in 2001 The US deal limited growth to 7.5% until 2008

130 Chapter 130 of © 2007 Worth Publishers International Economics Feenstra/Taylor Conclusions A tariff on imports is the most commonly used trade policy tool First considered a small country with no effect on world price Price faced by consumers and producers in the importing country will rise by the full amount of the tariff There is a drop in consumer surplus, a rise in producer surplus, and the government collects revenue Net loss for the importing country

131 Chapter 131 of © 2007 Worth Publishers International Economics Feenstra/Taylor Conclusions Why are tariffs used? Easy way for governments to raise revenue, especially in developing countries The government might care more about protecting firms than avoiding loses for consumers The small-country assumption may not hold in practicecountries may be large enough to gain from a tariff If a country is large enough, they can have an effect on the world price

132 Chapter 132 of © 2007 Worth Publishers International Economics Feenstra/Taylor Conclusions In this case, prices rise by less than the full amount of the tariff It is therefore possible for a small tariff to generate welfare gains for the importing country This does come at the expense of the foreign exportersbeggar thy neighbor policy Overall still have world losses Countries also may choose quotas, which restrict the quantity of imports into a country WTO has tried to restrict the use of quotas Deletion of MFA quotas still lead to new quotas against China

133 Chapter 133 of © 2007 Worth Publishers International Economics Feenstra/Taylor Conclusions Import quotas lead to similar welfare effects of tariffs Increase domestic price with loss for consumers and gains for producers Quota rents instead of guaranteed government revenues If resources are wasted by firms to gains rents, additional deadweight losses are incurred More common for foreign exporters to earn the quota rents - VER

134 Chapter 134 of © 2007 Worth Publishers International Economics Feenstra/Taylor Key Points 1.The government of a country a can use laws and regulations, called trade policies, to affect international trade flows 2.The rules governing grade policies in most countries are outlined by the General Agreement on Tariffs and Trade (GATT), now the World Trade Organization (WTO) 3.In a small country, the world price faced is fixed, so the price faced by consumers and producers will rise by the full amount of the tariff

135 Chapter 135 of © 2007 Worth Publishers International Economics Feenstra/Taylor Key Points 4.The use of a tariff by a small importing country always leads to a net loss in welfare 5.In a large country, the change in imports from a tariff will lower world price so the price to the importing country does not rise by the full amount of the tariff 6.The use of a tariff for a large country can lead to a net gain in welfare 7.The optimal tariff is the tariff amount that maximizes welfare for the importer 8.The formula for the optimal tariff depends inversely on the foreign export supply elasticity

136 Chapter 136 of © 2007 Worth Publishers International Economics Feenstra/Taylor Key Points 9.Import quotas restrict the quantity of a particular import, thereby increasing the domestic price, benefiting domestic production and creating a benefit for those who are allowed to import the quantity allotted. Benefits are quota rents 10.Assuming perfectly competitive markets for goods, quotas are similar to tariffs since the restriction in the amount imported leads to a higher domestic price. Rents, however, can be earned by the foreign country and can create additional dead weight losses


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