1. The Impact of Trade Policies Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin Chapter 14

2. 14-2 Learning Objectives Illustrate how tariffs, quotas, and subsidies affect domestic markets. Identify the winners, losers, and net country welfare effects of protection. Explain how the effects of protection differ between large and small countries. Demonstrate how protection in one market can affect other markets in the economy.

3. 14-3 Consumer Surplus Consumer surplus (CS) is a measure of the overall well-being of consumers. CS is the area between the demand curve and the price. CS varies inversely with the price.

4. 14-4 Consumer Surplus D Q P P*P*

5. 14-5 Producer Surplus Producer surplus (PS) is a measure of the well-being of producers. PS is the area between the supply curve and the price. PS varies directly with price.

6. 14-6 Producer Surplus S Q P P *

7. 14-7 Trade Restrictions in Partial Equilibrium: The Small Country Case What happens when a country imposes a tariff? Its domestic price rises. Therefore, tariffs: benefit domestic producers harm domestic consumers generate tariff revenue for the government

8. Tariffs: Small Country Case D Q P S $1 $1.35 1000 2000 1250 1750 c db a CS falls by area a+b+c+d, or $656.25. PS rises by area a, or $393.75. Revenue rises by area c, or $175. Deadweight loss is areas b+d, or $87.50. 14-8

9. 14-9 Tariffs: Small Country Case A tariff makes producers better off, but overall, the small countrys welfare falls.

10. 14-10 Import Quotas: Small Country Case Recall that quotas and tariffs can be designed to be equivalent. The difference is that with quotas there is no revenue collected. Instead rent will be captured by holders of import licenses or the government if it auctions the licenses, or foreign suppliers, if they organize. The welfare implications of the quota are otherwise the same as for tariffs.

11. Production Subsidies: Small Country Case D Q P S $5 $6 100190120160 c b a A $1 subsidy has the effect of shifting the supply curve to the right. CS doesnt change, because consumers still pay $5. PS rises by areas a+b The cost of the subsidy is a+b+c Deadweight loss is areas c. S' 14-11

12. 14-12 Production Subsidies: Small Country Case Production subsidies lead to deadweight loss because of the expansion of relatively inefficient production. However, the DWL is less than would have occurred if an equivalent tariff or quota were used.

13. 14-13 Export Taxes: Small Country Case Export taxes cause the price in the imposing (i.e., exporting) country to fall, since some of what had been exported is not anymore. Wed predict an increase in CS, a decrease in PS, and a gain in revenue.

14. 14-14 Export Taxes: Small Country Case P Q S D P FT P ET CS rises by area a. PS falls by areas a+b+c+d. Revenue rises by area c. DWL is b+d. a d c b

15. 14-15 Export Taxes: Small Country Case An export tax tariff makes consumers better off, but overall, the small countrys welfare falls.

16. 14-16 Export Subsidies: Small Country Case Export subsidies cause the price in the imposing (i.e., exporting) country to rise, since more of what is produced is now exported. Wed predict an decrease in CS, an increase in PS. The subsidy will generate cost, not revenue.

17. 14-17 Export Subsidies: Small Country Case P Q S D P ES P FT CS falls by area a+b PS rises by areas a+b+c+d+e Subsidy cost is b+c+d+e+f Overall effect is a loss: b+f ad c b e f

18. 14-18 Export Subsidies: Small Country Case An export subsidy tariff makes producers better off, but overall, the small countrys welfare falls.

19. 14-19 Voluntary Export Restraints: Small Country Case Similar to tariffs or quotas, VERs raise the domestic price which lowers CS raises PS Rent, however, is captured by the exporting country. The imposing country will lose not only the DWL triangles, but also the rent rectangle; welfare falls.

20. 14-20 Tariffs: Large Country Case In the previous analysis, the tariff caused the imposing countrys price to rise by the full amount of the tariff. This would mean that the imposing country is small; if it imposes a tariff, it is unable to affect the world price. What if a country is not small?

21. Tariffs: Large Country Case P Q P Q S D S D Importing Country Exporting Country P FT a bd c e The tariff causes price to rise in the importing country; P falls in the exporting country. 14-21

22. Tariffs: Large Country Case P Q P Q S D S D Importing Country Exporting Country P FT a bd c e Importing country CS falls by a+b+c+d PS rises by area a. Revenue increases by areas c+e Overall effect: e–(b+d) 14-22

23. 14-23 Tariffs: Large Country Case A large country could increase its welfare by imposing a tariff if the revenue extracted from the exporting country (area e) is bigger than the deadweight loss (areas b+d). This assumes that the exporting country does not retaliate.

24. 14-24 Import Quotas: Large Country Case As with the tariff, IQs cause prices in the importing country to rise, and prices in the exporting country to fall. As with the tariff, if enough of the quota rent is transferred from the exporting country to offset the deadweight loss, a quota can increase a countrys overall welfare. This also assumes no retaliation.

25. 14-25 VERs: Large Country Case As with the tariff and the quota, VERs cause prices in the importing country to rise, and prices in the exporting country to fall. However, unlike quotas rent generated is captured by the exporting country. VERs are welfare-diminishing even in the large country case.

26. 14-26 Export Taxes: Large Country Case In the previous analysis, the export tax caused the imposing countrys price to fall by the full amount of the tax. If the exporting country is large, its price will fall somewhat but the price in the importing country will also rise.

27. Export Taxes: Large Country Case P Q P Q S D S D Importing Country Exporting Country P FT The export tax causes the price to fall in the exporting country and rise in the importing country. a bd c e 14-27

28. Export Taxes: Large Country Case P Q P Q S D S D Importing Country Exporting Country P FT CS rises by area a. PS falls by areas a+b+c+d Revenue rises by areas c+e a bd c e 14-28

29. 14-29 Export Taxes: Large Country Case A large country could increase its welfare by imposing an export tax if the revenue extracted from the importing country (area e) is bigger than the deadweight loss (areas b+d). This assumes that the importing country does not retaliate.

30. 14-30 Export Subsidies: Large Country Case CS falls. PS rises. But there is no revenue; instead cost. Overall, export subsidies are welfare-diminishing for small countries and for large countries.

31. 14-31 Trade Restrictions in General Equilibrium: The Small Country Case We can use general equilibrium analysis to better understand the economy-wide effects of protection. A tariff on imports of good Y will stimulate domestic production. The economy winds up on a lower indifference curve.

32. Tariffs in General Equilibrium: Small Country Case Y X B0B0 C0C0 B1B1 (P x /P y ) 0 C1C1 P x /P y (1+t) In free trade, producer equilibrium is at B 0, and consumer equilibrium is at C 0. The tariff changes production to point B 1 ;consumption moves to C 1 (on a lower indifference curve). 14-32

33. 14-33 Trade Restrictions in General Equilibrium: The Large Country Case To understand the effects of protectionism in the large country case we can use offer curve analysis.

34. 14-34 Tariffs or Export Taxes Y X (P X /P Y ) FT X2X2 Y2Y2 OC A OC B OC A ' (P X /P Y ) t By imposing a tariff or an export tax, Country A decreases trade volume, but improves its terms of trade (note: Bs terms of trade deteriorate). Y1Y1 X1X1

35. 14-35 Export Subsidies Y X (P X /P Y ) FT X1X1 Y1Y1 OC A OC B (P X /P Y ) ES X2X2 Y2Y2 Country As terms of trade deteriorate; volume rises.

36. 14-36 Import Quotas Y X (P X /P Y ) FT X1X1 Y1Y1 OC FT A OC FT B OC IQ A Y2Y2 The quota causes the imposing countrys terms of trade to improve, and trade volume to fall. (P X /P Y ) IQ X2X2

37. 14-37 VERs Y X (P X /P Y ) E X1X1 Y1Y1 OC FT A OC FT B OC VER B Y2Y2 The quota decreases trade volume, and causes As terms of trade to deteriorate.