The Instruments of Trade Policy: Part I, Tariffs

The Instruments of Trade Policy: Part I, Tariffs
Eastwood's ECO486 Notes The Instruments of Trade Policy: Part I, Tariffs INTERNATIONAL ECONOMICS, ECO 486 Harmonized tariff schedule (HTS) of the United States: Tariffs

Learning Objectives Reprise the gains from trade
Eastwood's ECO486 Notes 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 Tariffs

Gains from Trade Static Gains (PPF doesn’t shift)
Eastwood's ECO486 Notes Gains from Trade Static Gains (PPF doesn’t shift) Consumption gains Production gains Dynamic Gains (PPF does shift) Trade expands resources Trade may raise productivity Political Gains Tariffs

Consumption & Production Gains
Eastwood's ECO486 Notes Consumption & Production Gains rF C B CIC2 A CIC1 TEXTILES, T (yards per year) CIC0 X SOYBEANS, S (bushels per year) Tariffs

Consumption & Production Gains
Eastwood's ECO486 Notes Consumption & Production Gains PS/PT = rS = |slope of terms of trade line| rF C A to B shows consumption gains B to C shows production gains B CIC2 A CIC1 TEXTILES, T (yards per year) CIC0 X SOYBEANS, S (bushels per year) Tariffs

Dynamic Gains from Trade
Eastwood's ECO486 Notes Dynamic Gains from Trade Trade may speed economic growth Tariffs

Dynamic Gains from Trade
Eastwood's ECO486 Notes Dynamic Gains from Trade Trade may speed economic growth When more K goods are imported than produced in autarky, PPF shifts out. Trade diffuses new technology. Trade raises real income. Savings rise. Free trade an effective anti-trust policy Trade expands the market, allowing firms to exploit IRS. When trade spurs development, decreasing-costs may occur. Tariffs

Eastwood's ECO486 Notes Commercial Policy Governments action that may change the composition and volume of trade flows Tariffs Quotas Subsidies Other non-tariff barriers We’ll analyze the cost & benefits of these Tariffs

Tariffs Taxes on Components -- See HTS Imports Exports Subsidies
Eastwood's ECO486 Notes Tariffs Taxes on Imports Exports Subsidies Components -- See HTS Ad valorem-- % of value Specific -- flat fee per unit Compound -- both Tariffs

Positive Effects of Tariffs
Eastwood's ECO486 Notes Positive Effects of Tariffs Revenue Effect -- provide tax revenue Protective Effect -- shelter domestic producers from foreign competition Tariffs

Eastwood's ECO486 Notes 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 Tariffs

Eastwood's ECO486 Notes Uses of Tariffs Developing countries may rely on tariffs to provide tax revenue Developed countries impose tariffs for their protective effect Tariffs

Tariffs as tools of int’l 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

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

Gains from free trade -- imports
Eastwood's ECO486 Notes Gains from free trade -- imports 10 Price ($ per bushel of grapes) 6 3 2 1 4 7 10 Quantity (millions bushels of grapes per year) Tariffs

Gains from free trade -- imports
Eastwood's ECO486 Notes Gains from free trade -- imports Domestic Supply of grapes 10 Price ($ per bushel of grapes) 6 a b c 3 World price of grapes 2 Domestic demand for grapes 1 4 7 10 Quantity (millions bushels of grapes per year) Tariffs

Welfare of a Move to Free Trade A Small Country’s Imports
Eastwood's ECO486 Notes Welfare of a Move to Free Trade A Small Country’s Imports Tariffs

Gains from free trade -- exports
Eastwood's ECO486 Notes Gains from free trade -- exports 10 9 Price ($ per jar of honey) 6 2 1 4 7 10 Quantity (millions jars of honey per year) Tariffs

Gains from free trade -- exports
Eastwood's ECO486 Notes Gains from free trade -- exports Domestic Supply of honey 10 9 World price of honey Price ($ per jar of honey) g e f 6 2 Domestic demand for honey 1 4 7 10 Quantity (millions jars of honey per year) Tariffs

Welfare of a Move to Free Trade A Small Country’s Exports
Eastwood's ECO486 Notes Welfare of a Move to Free Trade A Small Country’s Exports Tariffs

Welfare Cost of a Tariff on Imports -- Small Country
Eastwood's ECO486 Notes Welfare Cost of a Tariff on Imports -- Small Country 10 Price ($ per bushel of grapes) 5 3 2 1 3 5 7 10 Quantity (millions bushels of grapes per year) Tariffs

Eastwood's ECO486 Notes Welfare Cost of a Tariff on Imports -- Small Country Domestic Supply of grapes 10 Price ($ per bushel of grapes) 5 World price + tariff $2/bu c a b d 3 World price of grapes 2 Domestic demand for grapes 1 3 5 7 10 Quantity (millions bushels of grapes per year) Tariffs

Eastwood's ECO486 Notes Welfare Cost of a Tariff on Imports -- Small Country Loss = 0.5 x tariff x change in imports Tariffs

Welfare Cost of a Tariff Small Country
Eastwood's ECO486 Notes Welfare Cost of a Tariff Small Country Domestic Supply of grapes 10 Price ($ per bushel of grapes) 5 World price + tariff $2/bu c b d 3 World price of grapes 2 Domestic demand for grapes 1 3 5 7 10 Quantity (millions bushels of grapes per year) Tariffs

Eastwood's ECO486 Notes Welfare Cost of a Tariff on Imports -- Small Country Domestic Supply of grapes 10 Price ($ per bushel of grapes) 5 World price + tariff $2/bu a2 c a1 b d 3 World price of grapes 2 Domestic demand for grapes 1 3 5 7 10 Quantity (millions bushels of grapes per year) Tariffs

Export Tariff -- Small Country
Eastwood's ECO486 Notes Export Tariff -- Small Country Domestic Supply of honey 10 9 Price ($ per jar of honey) 6 2 Domestic demand for honey 1 4 7 10 Quantity (millions jars of honey per year) Tariffs

Export Tariff -- Small Country
Eastwood's ECO486 Notes Export Tariff -- Small Country Domestic Supply of honey 10 9 PW d b c Price ($ per jar of honey) a PW -T 6 2 Domestic demand for honey 1 4 7 10 Quantity (millions jars of honey per year) Tariffs

Welfare Cost -- Export Tariff Small Country Case
Eastwood's ECO486 Notes Welfare Cost -- Export Tariff Small Country Case Tariffs

Int’l Free Trade Eq. Large Country
Eastwood's ECO486 Notes Int’l Free Trade Eq. Large Country Price ($ per lb.) PA PB Quantity (lb. of Lobster per year) Tariffs

Int’l Free Trade Eq. Large Country
Eastwood's ECO486 Notes Int’l Free Trade Eq. Large Country Price ($ per lb.) A’s Supply of L B’s Supply of L PA PFT PFT PB A’s demand for L B’s demand for L Q1’ Q2’ Q1 Q2 Quantity (lb. of Lobster per year) Tariffs

Import Demand Price ($ per lb.) Price ($ per lb.)
Eastwood's ECO486 Notes Import Demand Price ($ per lb.) A’s Supply of Lobster Price ($ per lb.) PA PA PFT PB PB A’s demand for Lobster M = QD - QS Quantity (lb. of Lobster per year) Tariffs

Import Demand Price ($ per lb.) Price ($ per lb.)
Eastwood's ECO486 Notes Import Demand Price ($ per lb.) A’s Supply of Lobster Price ($ per lb.) PA PA PFT PB PB A’s demand for imported lobster (excess demand); |slope| = rise/(sum of runs) A’s demand for Lobster M = QD - QS Quantity (lb. of Lobster per year) Tariffs

Export Supply Price ($ per lb.) Quantity (lb. of Lobster per year)
Eastwood's ECO486 Notes Export Supply Price ($ per lb.) B’s Supply of L PA PB PB B’s demand for L QD QS X = QS - QD Quantity (lb. of Lobster per year) Tariffs

Export Supply Price ($ per lb.) Quantity (lb. of Lobster per year)
Eastwood's ECO486 Notes Export Supply B’s Supply of exports, excess supply; slope = rise/(sum of runs) Price ($ per lb.) B’s Supply of L PA PB PB B’s demand for L QD QS X = QS - QD Quantity (lb. of Lobster per year) Tariffs

Export Supply & Import Demand
Eastwood's ECO486 Notes Export Supply & Import Demand A’s demand for Lobster A’s Supply of Lobster Price ($ per lb.) PA PFT Q1 Q2 Price ($ per lb.) Export Supply, X PA PFT PFT PB Import Demand, M M = Q2 - Q1 Quantity (lb. of Lobster per year) Tariffs

Export Supply & Import Demand
Eastwood's ECO486 Notes Export Supply & Import Demand Price ($ per lb.) B’s Supply of L Export Supply, X PA PFT PFT PB PB Import Demand, M B’s demand for L Q1’ Q2’ M = Q2 - Q1 X = Q2‘ - Q1 ‘ Quantity (lb. of Lobster per year) Tariffs

Optimal Tariffs Retaliation is likely to offset this gain
Eastwood's ECO486 Notes 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 Tariffs

Equilibrium with a Tariff Large Country
Eastwood's ECO486 Notes Equilibrium with a Tariff Large Country Price ($ per lb.) A’s Supply of L B’s Supply of L P” PFT PFT P’ P’ A’s demand for L B’s demand for L Q1’ Q3’ Q4’ Q2’ Q1 Q3 Q4 Q2 Quantity (lb. of Lobster per year) Tariffs

Equilibrium with a Tariff Large Country
Eastwood's ECO486 Notes Equilibrium with a Tariff Large Country Price ($ per lb.) A’s Supply of L B’s Supply of L P” a c b d PFT PFT i j e h e P’ P’ A’s demand for L B’s demand for L Q1’ Q3’ Q4’ Q2’ Q1 Q3 Q4 Q2 Quantity (lb. of Lobster per year) Tariffs

A’s Welfare Cost -- Import Tariff Imposed by Large Country, A
Eastwood's ECO486 Notes A’s Welfare Cost -- Import Tariff Imposed by Large Country, A Tariffs

B’s Welfare Cost from A’s Tariff Import Tariff Imposed by A
Eastwood's ECO486 Notes B’s Welfare Cost from A’s Tariff Import Tariff Imposed by A Tariffs

World Welfare Cost of A’s Tariff
Eastwood's ECO486 Notes World Welfare Cost of A’s Tariff Tariffs

World Welfare Changes Tariff raises the price in A to P” = PW + T
Eastwood's ECO486 Notes World Welfare Changes Tariff raises the price in A to P” = PW + T Tariff lowers the world price to P’ = PW Tariff reduces the quantity world trade from Q1 Q2 to Q3 Q4 A’s welfare change = – b – d + e B’s welfare change = – e – i – j World welfare change = – b – d – i – j Tariffs

B Subsidizes its Exports Large Country Case
Eastwood's ECO486 Notes B Subsidizes its Exports Large Country Case Price ($ per lb.) A’s Supply of L B’s Supply of L P” P” PFT PFT P’ P’ A’s demand for Lobster B’s demand for Lobster Q3’ Q1’ Q2’ Q4’ Q3 Q1 Q2 Q4 Quantity (lb. of Lobster per year) Tariffs

B Subsidizes its Exports Large Country Case
Eastwood's ECO486 Notes B Subsidizes its Exports Large Country Case Price ($ per lb.) A’s Supply of L B’s Supply of L P” P” a c b d PFT PFT h j e f g i k P’ P’ A’s demand for Lobster B’s demand for Lobster Q3’ Q1’ Q2’ Q4’ Q3 Q1 Q2 Q4 Quantity (lb. of Lobster per year) Tariffs

B’s Welfare Cost from its Export Subsidy
Eastwood's ECO486 Notes B’s Welfare Cost from its Export Subsidy Tariffs

A’s Welfare Cost from B’s Export Subsidy
Eastwood's ECO486 Notes A’s Welfare Cost from B’s Export Subsidy Tariffs

World Welfare Cost from B’s Export Subsidy
Eastwood's ECO486 Notes World Welfare Cost from B’s Export Subsidy Tariffs

World Welfare Changes Export subsidy raises price in B to P” = PW + S
Eastwood's ECO486 Notes World Welfare Changes Export subsidy raises price in B to P” = PW + S Subsidy lowers the world price to P’ = PW World trade grows from Q1 Q2 to Q3 Q4 B’s welfare change = – b – d – e – f – g A’s welfare gain = + i + j + k World welfare change = – b – d – e – f – g + i + j + k Tariffs

Nominal & Effective Rates of Protection
Eastwood's ECO486 Notes 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 Tariffs

Nominal & Effective Rates of Protection
Eastwood's ECO486 Notes 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 The NRP is the ad valorem tariff rate. In the case of a specific tariff (or a compound tariff), it is the equivalent ad valorem tariff rate, expressed as a percentage of the free-trade price of the good. The ERP is the percentage increase in domestic value added as a result of trade policy. Tariffs

Effective Rate of Protection
Eastwood's ECO486 Notes Effective Rate of Protection gj = Effective Rate of Protection on final product j tj = nominal tariff rate on final product j ti = nominal tariff rate on imported input i aij = share of i in the total value of j in the absence of tariffs Tariffs

Welfare Cost of Tariffs as a Percentage of GDP
Eastwood's ECO486 Notes 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 Tariffs & NTBs often exclude new goods (e.g., computers, just-in-time inventory processes) Tariffs

Welfare Cost of Tariffs as a Percentage of GDP
Eastwood's ECO486 Notes 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% Tariffs & NTBs often exclude new goods (e.g., computers, just-in-time inventory processes) Tariffs

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.

Eastwood's ECO486 Notes 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. Tariffs

Export Supply + Specific Tariff, T
Eastwood's ECO486 Notes Export Supply + Specific Tariff, T Price ($ per lb.) T Export Supply, X T Import Demand, M MFT Quantity (lb. of Lobster per year) Tariffs

Eastwood's ECO486 Notes Export Supply + Specific Tariff, T Price ($ per lb.) X + TARIFF, T T PA Export Supply, X PW +T f PFT g PW T PB Import Demand, M MT MFT Quantity (lb. of Lobster per year) Tariffs

Eastwood's ECO486 Notes 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 (1 + t) = (a + b q) (1 + t) = (1 + t) a + (1 + t) b q Tariffs

Export Supply with Ad-Valorem Tariff, t
Eastwood's ECO486 Notes Export Supply with Ad-Valorem Tariff, t Price ($ per lb.) X(1+t) PA Export Supply, X PW +T f PFT g PW PB Import Demand, M MT MFT Quantity (lb. of Lobster per year) Tariffs

Price Elasticity of Demand, ed
ed and slope are inversely related.

The Price Elasticity of Supply, es
Eastwood's ECO486 Notes The Price Elasticity of Supply, es The formula for price elasticity of supply, es, at a point is shown below. Note that it’s the same as the formula for ed , but lacks the absolute value notation Tariffs

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

Import Demand Elasticity, em
Eastwood's ECO486 Notes Import Demand Elasticity, em The formula for price elasticity of import demand, em, at a point is shown below Qm is the quantity of imports; Qd is the quantity demanded; Qs is the quantity supplied Tariffs

Interpreting em em is directly related to A’s ed and es
Eastwood's ECO486 Notes Interpreting em em is directly related to A’s ed and es em is inversely related to the share of imports in A’s consumption and production Tariffs

Export Supply Elasticity, ex
Eastwood's ECO486 Notes Export Supply Elasticity, ex The formula for price elasticity of export supply, ex, at a point is shown below. Q is the quantity of exports; P is the price; DP is the change in price; DQ is the change quantity exported Tariffs

Export Supply Elasticity, ex
Eastwood's ECO486 Notes Export Supply Elasticity, ex The formula for price elasticity of export supply, ex, at a point is shown below. Qx is the quantity of exports; Qd is the quantity consumed; Qs is the quantity produced Tariffs

Interpreting ex ex is directly related to B’s ed and es
Eastwood's ECO486 Notes Interpreting ex ex is directly related to B’s ed and es ex is inversely related to the share of exports in B’s consumption and production Tariffs

Eastwood's ECO486 Notes Export Supply + Specific Tariff, T PA X + TARIFF, T PW +T T f A’s burden, b PFT Export Supply, X g PW PB Import Demand, M MT MFT Quantity (lb. of Lobster per year) Tariffs

Compare em and ex to determine A’s burden, b; 0£b£1
Eastwood's ECO486 Notes Compare em and ex to determine A’s burden, b; 0£b£1 When em = ex , b = _____ When em > ex , b _______ When em < ex , b _______ Tariffs

Compare em and ex to determine A’s burden, b; 0£b£1
Eastwood's ECO486 Notes Compare em and ex to determine A’s burden, b; 0£b£1 When em = ex , b = 0.5 When em > ex , b < 0.5 When em < ex , b > 0.5 Tariffs

Differing em Quantity (lb. of Lobster per year) PA X + TARIFF, T PW +T
Eastwood's ECO486 Notes Differing em PA X + TARIFF, T PW +T T PW +T Export Supply, X f A’s burden, b f PFT g B’s burden, 1- b g PW Elastic M PW Inelastic M MT MT MFT Quantity (lb. of Lobster per year) Tariffs

Differing ex Quantity (lb. of Lobster per year) PA Inelastic X + T T
Eastwood's ECO486 Notes Differing ex PA Inelastic X + T T Elastic X + T PW +T Inelastic X f A’s burden, b PFT Elastic X g PW PB T Import Demand, M MT MFT Quantity (lb. of Lobster per year) Tariffs

SUPACHAI CITES KEY NEGOTIATING AREAS
Eastwood's ECO486 Notes 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 WTO NEWS, 15 November 2002 : SUPACHAI CITES KEY NEGOTIATING AREAS DirectorGeneral Supachai Panitchpakdi, in his first annual report to members on developments in the international trading environment released on 15 November 2002, underlined that “trade liberalization and poverty reduction go hand in hand”. He cited recent estimates that eliminating trade barriers in all countries could result in welfare gains of up to US$620 billion annually, of which about one third to one half would go to developing countries. The DirectorGeneral said there is still “unfinished business on tariffs,” noting that “tariffs remain an important impediment to international trade, notwithstanding the considerable achievements of the Uruguay Round” He added that even in industrialized countries, where average tariff protection is low, tariff “peaks” exist in certain sectors, notably agricultural products, textiles, clothing and footwear. Dr. Supachai said another key area of interest is agriculture, which, “despite its small and diminishing contribution to GDP in most developed economies, receives a disproportionate amount of assistance in the form of subsidies and protection at the border”. Marketaccess conditions are also a key interest of members in trade in services, which are now among the fastest growing segments of world trade. Dr. Supachai said expectations are that “the gains from liberalizing services are substantially greater than those from liberalizing trade in goods”. The DirectorGeneral notes that there are around 240 regional trade agreements currently in force, and there could be close to 300 by He said that when fully in line with the WTO, these agreements can complement the strengthening and liberalization of world trade “but by discriminating against third countries and creating a complex network of trade regimes, such agreements pose systemic risk to the global trading system”. Dr. Supachai also notes that another area of key interest is the increasing use by more members, including developing countries, of contingency measures, particularly antidumping actions. > Annual Report by the DirectorGeneral Tariffs

Eastwood's ECO486 Notes 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 Tariffs

Imperfect Substitutes
Eastwood's ECO486 Notes 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 Tariffs

Imperfect Substitutes Small Country -- Free Market
Eastwood's ECO486 Notes Imperfect Substitutes Small Country -- Free Market SD Price Price of Import PD PM SM DM DD QM QD Quantity of Imports Quantity of Domestic Substitute Tariffs

Imperfect Substitutes Small Country -- Tariff
Eastwood's ECO486 Notes Imperfect Substitutes Small Country -- Tariff SD Price Price of Import i m k S’M j f n h l tariff e SM r g D’D D’M DM DD QD Q’M Q”M QM Q’D Quantity of Imports Quantity of Domestic Substitute Tariffs

Welfare Cost of a Tariff Imperfect Substitutes
Eastwood's ECO486 Notes Welfare Cost of a Tariff Imperfect Substitutes Tariffs

Eastwood's ECO486 Notes Review homework Tariffs

Trade with a Tariff Versus Autarky
Eastwood's ECO486 Notes Trade with a Tariff Versus Autarky Domestic Supply of grapes 10 Price ($ per bushel of grapes) 6 d e 5 World price + tariff $2/bu 3 World price of grapes 2 Domestic demand for grapes 1 3 5 7 10 Quantity (millions bushels of grapes per year) Tariffs

Pure Revenue Tariff Versus Free Trade
Eastwood's ECO486 Notes Pure Revenue Tariff Versus Free Trade Domestic Supply of grapes lies along y-axis 10 Price ($ per bushel of bananas) a 5 World price + tariff $2/bu b c 3 World price of bananas 2 Iceland’s demand for bananas 1 3 5 7 10 Quantity (millions bushels of bananas per year) Tariffs

Differing em Quantity (lb. of Lobster per year) PA X + TARIFF, T PW +T
Eastwood's ECO486 Notes Differing em PA X + TARIFF, T PW +T T PW +T f Export Supply, X f PFT g g PW Elastic M PW Inelastic M MT MT MFT Quantity (lb. of Lobster per year) Tariffs

The Instruments of Trade Policy: Part I, Tariffs

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The Instruments of Trade Policy: Part I, Tariffs

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