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1 Tariff Instruments Eco 3024F Krugman & Obstfeld Ch 8.

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Presentation on theme: "1 Tariff Instruments Eco 3024F Krugman & Obstfeld Ch 8."— Presentation transcript:

1 1 Tariff Instruments Eco 3024F Krugman & Obstfeld Ch 8

2 2 Outline Introduction: Relevance of tariffs Types of tariffs Partial equilibrium analysis of tariffs Costs and benefits of tariffs LATER: –Analysis of Tariffs (GE framework) –Trade policy in presence of monopolies 8-2

3 3 Trade theory is about identifying whose hand is in whose pocket. Trade policy is about who should take it out (Finger, 1981). Tariff -- A scale of taxes on imports, designed to protect the domestic producer against the greed of his consumer. From Ambrose Bierce, The Devil's Dictionary:

4 4 Why do we need to worry about tariffs and tariff policy? 1.Tariffs a key policy instrument used for industrial development Department of trade and industrys National Industrial Policy Framework 2.Trade negotiations WTO negotiations African countries negotiating new economic partnership agreements (EPAs) with EU Regional integration schemes (SADC Customs union by 2010) Business operations: imported goods used in production and consumption

5 5 Tariffs & other charges Goods imported into most countries are subject to different charges –Customs duties –Excise duties –Levies Flue cured tobacco: 3.3c/kg c/kg (special levy) Lentils: 9.60 R/T R/T (special levy) –VAT or sales tax

6 6 Types of import tariffs (Customs duties) Ad valorem tariff : P D = P W (1 + t) –Levied as a constant percentage of the monetary value of 1 unit of the imported good. Oranges: 5% –But because it is based on the value of the good, an importer may understate the value while customs may overvalue as a counter measure. Specific tariff: P D = P W + t –Import duty that assigns a fixed monetary (Rand) tax per physical unit of the good imported. Blue veined cheese: 500c/kg –It may be collected with ease because only physical quantity of imports needs to be known and not their monetary value –However, protection varies with value of imported good. So inflation lessens strength of tariff

7 7 Types of import tariffs (Customs duties) Compound tariffs –Ad valorem PLUS specific tariff –E.g. wheat flour :10% plus 29.4c/kg Mixed tariff –Either ad valorem OR specific (normally the one which yields higher protection) –E.g. Fish, fresh or chilled: 25% or 70c/kg

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9 9 Supply, Demand & Trade in a Single Industry Assume –Perfect competition in mkt for laptops. –Two countries in world producing laptops – SA & US –Initially No trade –Price of laptops in US lower than in SA With trade SA will import laptops –Import demand curve for laptops from SA With trade, US will export laptops –Export supply curve for laptops from US 8-9

10 10 Import demand curve 8-10 Import demand curve is downward sloping....why? What happens if P is above A? Import demand curve (MD): SA demand –SA supply= Import demand by SA (from US)

11 11 B Export supply curve 8-11 Export supply curve is upward sloping....why? What is happening at point B? Export supply curve (XS): US supply – US demand = Exports supplied to SA (by US)

12 12 World Equilibrium 8-12 At P w, XS=MD in SA Will P w be the mkt clearing price in US as well?

13 13 Partial equilibrium analysis of impact of tariffs

14 14 The Effects of a Tariff Suppose SA imposes tariff on computer imports –This is like a tax on the price of good imported or like the effect of transport costs (Imported price=foreign price + tariff) –Will introduce price wedge between domestic price (P T ) and foreign price (P * T ) P T – P * T = t What price adjusts, (P T ) or (P * T )? –As domestic price increases, quantity demanded falls in SA –As quantity demanded falls, so quantity supplied by US falls leading to possible foreign price decrease 8-14

15 15 The Effects of a Tariff (cont.) Price of the good in foreign (US) markets should fall if there is a significant drop in the quantity demanded of the good caused by the domestic (SA) tariff. 2.Extent of decline in foreign price depends on elasticity of foreign export supply and elasticity of import demand

16 16 The Effects of a Tariff (cont.) Domestic price rises and quantity of imports demanded falls Foreign price falls and quantity of exports supplied falls Gap between domestic and international price equals tariff wedge 8-16

17 17 Welfare: Who wins and who loses?

18 18 Welfare: Who wins and who loses?

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20 20 Cost and Benefit using a small country model Assumptions –Small country is unable to influence world price P world through changes in production and/or consumption –Implies: small countries face horizontal (infinitely elastic) Export supply curves

21 21 Small country supply and demand P W (1+t) S PWPW Q4Q1 D Q3Q2 BADC Imports at P W Consumer surplus loss Price Quantity Consumer surplus, no tariffsConsumer surplus, with tariffs

22 22 Dead weight loss Small country supply and demand P W +t S PWPW Q4Q1 D Q3Q2 BADC Government revenue gain Producer surplus gain Price Quantity Consumer loss-producer gain - government revenue = dead weight loss (B+D)

23 23 Small country: conclusion Tariffs raise domestic production by raising the price received Consumers pay for this through higher prices Governments gain from tariff revenue, which they can transfer back to consumers But price distortions lead to inefficient allocation of resources for consumers and producers Whose hand is in whose pocket? –Tariffs lead to a transfer of surplus from consumers to producers 8-23

24 24 Tariffs in large countries P W* +t S PWPW Q4Q1 D Q3Q2 B A D C Price Quantity P W* t E Consumer surplus loss

25 25 Tariffs in large countries P W* +t S PWPW Q4Q1 D Q3Q2 B A D C Government revenue gain Producer surplus gain Price Quantity Consumer loss - producer gain - government revenue = B+D-E P W* t E

26 26 Large country: conclusion Tariffs lower the world price Foreign producers bear some of cost of tariff through lower world prices –Terms of trade improvement for Home Tariffs still cause production and consumption efficiency losses BUT, if terms of trade improvement are large enough (area E), then the economy can gain Would you advise such a strategy? Why not?

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