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1 The Instruments of Trade Policy: Part I, Tariffs INTERNATIONAL ECONOMICS, ECO 486 Harmonized tariff schedule (HTS) of the United States:

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Presentation on theme: "1 The Instruments of Trade Policy: Part I, Tariffs INTERNATIONAL ECONOMICS, ECO 486 Harmonized tariff schedule (HTS) of the United States:"— Presentation transcript:

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2 1 The Instruments of Trade Policy: Part I, Tariffs INTERNATIONAL ECONOMICS, ECO 486 Harmonized tariff schedule (HTS) of the United States: s.htm#HTS s.htm#HTS

3 2 Learning Objectives Reprise the gains from trade Analyze the welfare cost of tariffs Determine the optimal tariff Analyze export subsidies Explain the effective rate of protection

4 3 Learning Objectives Reprise the gains from trade Analyze the welfare cost of tariffs Determine the optimal tariff Analyze export subsidies Explain the effective rate of protection

5 4 Gains from Trade Static Gains (PPF doesnt shift) –Consumption gains –Production gains Dynamic Gains (PPF does shift) –Trade expands resources –Trade may raise productivity Political Gains

6 5 SOYBEANS, S (bushels per year) 0 A TEXTILES, T (yards per year) CIC 0 Consumption & Production Gains CIC 1 CIC 2 F B C X

7 6 SOYBEANS, S (bushels per year) 0 A TEXTILES, T (yards per year) CIC 0 Consumption & Production Gains CIC 1 CIC 2 F B C X P S /P T = S = |slope of terms of trade line| A to B shows consumption gains B to C shows production gains

8 7 Dynamic Gains from Trade Trade may speed economic growth

9 8 Dynamic Gains from Trade Trade may speed economic growth –W–When more K goods are imported than produced in autarky, PPF shifts out. –T–Trade diffuses new technology. –T–Trade raises real income. Savings rise. –F–Free trade an effective anti-trust policy –T–Trade expands the market, allowing firms to exploit IRS. –W–When trade spurs development, decreasing- costs may occur.

10 9 Learning Objectives Reprise the gains from trade Analyze the welfare cost of tariffs Determine the optimal tariff Analyze export subsidies Explain the effective rate of protection

11 10 Commercial Policy Governments action that may change the composition and volume of trade flows –Tariffs –Quotas –Subsidies –Other non-tariff barriers Well analyze the cost & benefits of these

12 11 Tariffs Taxes on –Imports –Exports –Subsidies Components -- See HTS –Ad valorem-- % of value –Specific -- flat fee per unit –Compound -- both

13 12 Positive Effects of Tariffs Revenue Effect -- provide tax revenue Protective Effect -- shelter domestic producers from foreign competition

14 13 Tariff Terminology A pure-revenue tariff is one imposed on a good not produced domestically –A tariff on bananas imported to Iceland A prohibitive tariff is one that is so high that none of the good is imported –no revenue is collected

15 14 Uses of Tariffs Developing countries may rely on tariffs to provide tax revenue Developed countries impose tariffs for their protective effect

16 15 Tariffs as tools of intl policy Most Favored Nation status, MFN –granted as a reward, withheld as a punishment Generalized System of Preferences, GSP –Most developed countries have GSP as means of helping developing countries access to markets of developed countries

17 16 Welfare Cost Analysis Use (National) Supply and Demand –Partial equilibrium –One import or export good Measure Changes in Consumer Surplus and Producer Surplus Start with a small country –Its trade is too small to affect terms of trade

18 17 Gains from free trade -- imports Quantity (millions bushels of grapes per year) Price ($ per bushel of grapes) 7 2

19 18 Gains from free trade -- imports b Domestic demand for grapes Domestic Supply of grapes a c Quantity (millions bushels of grapes per year) Price ($ per bushel of grapes) World price of grapes 7 2

20 19 Welfare of a Move to Free Trade A Small Countrys Imports

21 20 Welfare of a Move to Free Trade A Small Countrys Imports

22 21 Gains from free trade -- exports Quantity (millions jars of honey per year) Price ($ per jar of honey) 7 2

23 22 Gains from free trade -- exports f Domestic demand for honey Domestic Supply of honey g Quantity (millions jars of honey per year) Price ($ per jar of honey) World price of honey 7 e 2

24 23 Welfare of a Move to Free Trade A Small Countrys Exports

25 24 Welfare of a Move to Free Trade A Small Countrys Exports

26 25 Welfare Cost of a Tariff on Imports -- Small Country Quantity (millions bushels of grapes per year) Price ($ per bushel of grapes)

27 26 Welfare Cost of a Tariff on Imports -- Small Country b Domestic demand for grapes Domestic Supply of grapes a c Quantity (millions bushels of grapes per year) Price ($ per bushel of grapes) World price of grapes 7 2 World price + tariff $2/bu 35 d

28 27 Welfare Cost of a Tariff on Imports -- Small Country Loss = 0.5 x tariff x change in imports

29 28 Welfare Cost of a Tariff on Imports -- Small Country Loss = 0.5 x tariff x change in imports

30 29 Welfare Cost of a Tariff Small Country b Domestic demand for grapes Domestic Supply of grapes c Quantity (millions bushels of grapes per year) Price ($ per bushel of grapes) World price of grapes 7 2 World price + tariff $2/bu 35 d

31 30 Welfare Cost of a Tariff on Imports -- Small Country b Domestic demand for grapes Domestic Supply of grapes a1a1 c Quantity (millions bushels of grapes per year) Price ($ per bushel of grapes) World price of grapes 7 2 World price + tariff $2/bu 35 d a2a2

32 31 Export Tariff -- Small Country Domestic demand for honey Domestic Supply of honey Quantity (millions jars of honey per year) Price ($ per jar of honey) 7 2

33 32 Export Tariff -- Small Country b Domestic demand for honey Domestic Supply of honey c Quantity (millions jars of honey per year) Price ($ per jar of honey) PWPW 7 a 2 P W -T d

34 33 Welfare Cost -- Export Tariff Small Country Case

35 34 Welfare Cost -- Export Tariff Small Country Case

36 35 Learning Objectives Reprise the gains from trade Analyze the welfare cost of tariffs Determine the optimal tariff Analyze export subsidies Explain the effective rate of protection

37 36 Intl Free Trade Eq. Large Country Quantity (lb. of Lobster per year) 0 Price ($ per lb.) PAPA PBPB 0

38 37 Intl Free Trade Eq. Large Country Quantity (lb. of Lobster per year) 0 As demand for L As Supply of L Price ($ per lb.) PAPA P FT Q1Q1 Q2Q2 PBPB Bs demand for L Bs Supply of L Q 1 Q 2 0

39 38 0 As demand for Lobster As Supply of Lobster Price ($ per lb.) PAPA P FT Import Demand Quantity (lb. of Lobster per year) PBPB 0 Price ($ per lb.) PAPA M = Q D - Q S PBPB

40 39 0 As demand for Lobster As Supply of Lobster Price ($ per lb.) PAPA P FT Import Demand Quantity (lb. of Lobster per year) PBPB 0 As demand for imported lobster (excess demand); |slope| = rise/(sum of runs) Price ($ per lb.) PAPA M = Q D - Q S PBPB

41 40 Export Supply 0 Quantity (lb. of Lobster per year) Price ($ per lb.) PAPA X = Q S - Q D PBPB Bs demand for L Bs Supply of L QDQD QSQS 0 PBPB

42 41 Export Supply 0 Bs Supply of exports, excess supply; slope = rise/(sum of runs) Quantity (lb. of Lobster per year) Price ($ per lb.) PAPA X = Q S - Q D PBPB Bs demand for L Bs Supply of L QDQD QSQS 0 PBPB

43 42 0 As demand for Lobster As Supply of Lobster Price ($ per lb.) PAPA P FT Q1Q1 Q2Q2 Export Supply & Import Demand Quantity (lb. of Lobster per year) 0 PBPB 0 Price ($ per lb.) PAPA P FT M = Q 2 - Q 1 P FT Export Supply, X Import Demand, M

44 43 Export Supply & Import Demand 0 Import Demand, M Export Supply, X Quantity (lb. of Lobster per year) Price ($ per lb.) PAPA P FT 0 M = Q 2 - Q 1 X = Q 2 - Q 1 PBPB P FT Bs demand for L Bs Supply of L Q 1 Q 2 0 PBPB

45 44 Optimal Tariffs Large countries may force foreign producer to pay part of their tariff. Because they are important customers, they force foreign suppliers to cut price. The optimal tariff maximizes the net welfare change Retaliation is likely to offset this gain

46 45 Equilibrium with a Tariff Large Country 0 As demand for L As Supply of L Quantity (lb. of Lobster per year) Price ($ per lb.) P FT Q1Q1 Q2Q2 Bs demand for L Bs Supply of L 0 P P P Q 1 Q3Q3 Q4Q4 Q 2 Q 3 Q 4

47 46 Equilibrium with a Tariff Large Country 0 As demand for L As Supply of L Quantity (lb. of Lobster per year) Price ($ per lb.) P FT Q1Q1 Q2Q2 Bs demand for L Bs Supply of L 0 P P P Q 1 Q3Q3 Q4Q4 Q 2 Q 3 Q 4 ac d ee b h i j

48 47 As Welfare Cost -- Import Tariff Imposed by Large Country, A

49 48 As Welfare Cost -- Import Tariff Imposed by Large Country, A

50 49 Bs Welfare Cost from As Tariff Import Tariff Imposed by A

51 50 Bs Welfare Cost from As Tariff Import Tariff Imposed by A

52 51 World Welfare Cost of As Tariff

53 52 World Welfare Cost of As Tariff

54 53 World Welfare Changes Tariff raises the price in A to P = P W + T Tariff lowers the world price to P = P W Tariff reduces the quantity world trade from Q 1 Q 2 to Q 3 Q 4 As welfare change = – b – d + e Bs welfare change = – e – i – j World welfare change = – b – d – i – j

55 54 Learning Objectives Reprise the gains from trade Analyze the welfare cost of tariffs Determine the optimal tariff Analyze export subsidies Explain the effective rate of protection

56 55 B Subsidizes its Exports Large Country Case 0 As Supply of L Quantity (lb. of Lobster per year) Price ($ per lb.) P FT Q1Q1 Q2Q2 Bs demand for Lobster Bs Supply of L 0 P P P Q 1 Q3Q3 Q4Q4 Q 2 Q 3 Q 4 P As demand for Lobster

57 56 B Subsidizes its Exports Large Country Case 0 As Supply of L Quantity (lb. of Lobster per year) Price ($ per lb.) P FT Q1Q1 Q2Q2 Bs demand for Lobster Bs Supply of L 0 P P P Q 1 Q3Q3 Q4Q4 Q 2 Q 3 Q 4 h j e a f c P db k i g As demand for Lobster

58 57 Bs Welfare Cost from its Export Subsidy

59 58 Bs Welfare Cost from its Export Subsidy

60 59 As Welfare Cost from Bs Export Subsidy

61 60 As Welfare Cost from Bs Export Subsidy

62 61 World Welfare Cost from Bs Export Subsidy

63 62 World Welfare Cost from Bs Export Subsidy

64 63 World Welfare Changes Export subsidy raises price in B to P = P W + S Subsidy lowers the world price to P = P W World trade grows from Q 1 Q 2 to Q 3 Q 4 Bs welfare change = – b – d – e – f – g As welfare gain = + i + j + k World welfare change = – b – d – e – f – g + i + j + k

65 64 Learning Objectives Reprise the gains from trade Analyze the welfare cost of tariffs Determine the optimal tariff Analyze export subsidies Explain the effective rate of protection

66 65 Nominal & Effective Rates of Protection t = tariff P = free-trade price of good v = domestic value added with free trade v= domestic value added with tariff

67 66 Nominal & Effective Rates of Protection t = tariff ($/unit) P = free-trade price of good v = domestic value added with free trade v= domestic value added with tariff

68 67 Effective Rate of Protection g j = Effective Rate of Protection on final product j t j = nominal tariff rate on final product j t i = nominal tariff rate on imported input i a ij = share of i in the total value of j in the absence of tariffs

69 68 Welfare Cost of Tariffs as a Percentage of GDP Traditional: Square the tariff rate –Ten percent tariff reduces GDP by 1% Tariffs & NTBs often exclude new goods –GDP loss almost twice the tariff rate

70 69 Welfare Cost of Tariffs as a Percentage of GDP Traditional: Square the tariff rate –Ten percent tariff reduces GDP by 1% Tariffs & NTBs often exclude new goods –GDP loss almost twice the tariff rate –Ten percent tariff lowers GDP by 19.8% –Twenty-five percent tariff lowers GDP by 47%

71 70 Consumers Surplus Consumers Surplus is the difference between consumers maximum willingness-to-pay and the amount they actually paid. The amount actually paid equals PQ. Graphically, Consumers Surplus (CS) is the area under the demand curve above P.

72 71 Producer Surplus Producer surplus is the price of a good minus the opportunity cost of producing it. –Graphically, Producers Surplus (PS) is the area under the Price line and above Supply.

73 72 Export Supply + Specific Tariff, T 0 Import Demand, M Export Supply, X Quantity (lb. of Lobster per year) Price ($ per lb.) M FT T T

74 73 Export Supply + Specific Tariff, T 0 Import Demand, M Export Supply, X Quantity (lb. of Lobster per year) Price ($ per lb.) PAPA P FT M FT PBPB X + TARIFF, T P W +T PWPW MTMT T T g f

75 74 Graphing Tariffs Specific tariff raises the y-intercept of the export supply curve, p = a + b q p + T = a + b q + T Ad-valorem tariff raises the slope and y-intercept of the export supply curve p = a + b q p (1 + t) = (a + b q) (1 + t) = (1 + t) a + (1 + t) b q

76 75 Export Supply with Ad-Valorem Tariff, t 0 Import Demand, M Export Supply, X Quantity (lb. of Lobster per year) Price ($ per lb.) PAPA P FT M FT PBPB X(1+t) P W +T PWPW MTMT g f

77 76 Price Elasticity of Demand, e d e d and slope are inversely related.

78 77 The Price Elasticity of Supply, e s The formula for price elasticity of supply, e s, at a point is shown below. Note that its the same as the formula for e d, but lacks the absolute value notation

79 78 Import Demand Elasticity, e m The formula for price elasticity of import demand, e m, at a point is shown below. Q is the quantity of imports; P is the price; P is the change in price; Q is the change quantity imported

80 79 Import Demand Elasticity, e m The formula for price elasticity of import demand, e m, at a point is shown below Q m is the quantity of imports; Q d is the quantity demanded; Q s is the quantity supplied

81 80 Interpreting e m e m is directly related to As e d and e s e m is inversely related to the share of imports in As consumption and production

82 81 Export Supply Elasticity, e x The formula for price elasticity of export supply, e x, at a point is shown below. Q is the quantity of exports; P is the price; P is the change in price; Q is the change quantity exported

83 82 Export Supply Elasticity, e x The formula for price elasticity of export supply, e x, at a point is shown below. – Q x is the quantity of exports; Q d is the quantity consumed; Q s is the quantity produced

84 83 Interpreting e x e x is directly related to Bs e d and e s e x is inversely related to the share of exports in Bs consumption and production

85 84 Export Supply + Specific Tariff, T 0 Import Demand, M Export Supply, X Quantity (lb. of Lobster per year) PAPA P FT M FT PBPB X + TARIFF, T P W +T PWPW MTMT T g f As burden, b

86 85 Compare e m and e x to determine As burden, b; 0 b 1 When e m = e x, b = _____ When e m > e x, b _______ When e m < e x, b _______

87 86 Compare e m and e x to determine As burden, b; 0 b 1 When e m = e x, b = 0.5 When e m > e x, b < 0.5 When e m 0.5

88 87 Bs burden, 1- b PWPW Differing e m 0 Inelastic M Export Supply, X Quantity (lb. of Lobster per year) PAPA P FT M FT X + TARIFF, T P W +T PWPW MTMT T g f As burden, b Elastic M MTMT P W +T f g

89 88 Differing e x 0 Import Demand, M Elastic X Quantity (lb. of Lobster per year) PAPA P FT M FT PBPB Elastic X + T P W +T PWPW MTMT T g f As burden, b Inelastic X T Inelastic X + T

90 89 SUPACHAI CITES KEY NEGOTIATING AREAS Trade liberalization and poverty reduction –Welfare gains from eliminating trade barriers gains of up to US$620 billion annually about one third to one half would go to developing countries. Tariff peaks –agricultural products, textiles, clothing and footwear Market­access conditions key in trade in services Regional trade agreements – 240 currently in force, perhaps 300 by 2005 Increasing use of contingency measures –e. g., anti-dumping

91 90 Learning Objectives Reprise the gains from trade Become familiar with tariffs Analyze the welfare cost of tariffs Determine the optimal tariff Explain the effective rate of protection Learn the imperfect substitutes model

92 91 Imperfect Substitutes Increased trade in final products relative to raw materials and intermediate goods A final-good import and competing domestic products are often imperfect substitutes Tariff increases demand for the domestic good Increased price of domestic good increases demand for the import Welfare cost is more difficult to estimate

93 92 Imperfect Substitutes Small Country -- Free Market 0 DMDM Quantity of Imports Price of Import PMPM QMQM QDQD 0 SMSM Quantity of Domestic Substitute D SDSD PDPD Price

94 93 Imperfect Substitutes Small Country -- Tariff 0 DMDM Quantity of Imports Price of Import e QMQM QDQD 0 SMSM Quantity of Domestic Substitute D SDSD l Price f D DMDM SMSM m h i r g k j n tariff QDQD QMQM QMQM

95 94 Welfare Cost of a Tariff Imperfect Substitutes

96 95 Welfare Cost of a Tariff Imperfect Substitutes

97 96 Review homework

98 97 Trade with a Tariff Versus Autarky Domestic demand for grapes Domestic Supply of grapes e Quantity (millions bushels of grapes per year) Price ($ per bushel of grapes) World price of grapes 7 2 World price + tariff $2/bu 35 d 3

99 98 Pure Revenue Tariff Versus Free Trade Icelands demand for bananas Domestic Supply of grapes lies along y-axis a Quantity (millions bushels of bananas per year) Price ($ per bushel of bananas) World price of bananas 7 2 World price + tariff $2/bu 35 b 3 c

100 99 PWPW Differing e m 0 Inelastic M Export Supply, X Quantity (lb. of Lobster per year) PAPA P FT M FT X + TARIFF, T P W +T PWPW MTMT T g f Elastic M MTMT P W +T f g


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