Presentation on theme: "Trade Policy: Instruments and Impacts"— Presentation transcript:
1 Trade Policy: Instruments and Impacts Appleyard & Field (& Cobbs): Chapters 13–14Krugman & Obstfeld: Chapter 8
2 Today’s Lecture Instruments of trade policy Impact of trade policies TariffsQuotasOther Non-tariff Barriers to TradeImpact of trade policiesPartial Equilibrium: Small CountryPartial Equilibrium: Large CountryGeneral Equilibrium: Small CountryGeneral Equilibrium: Large Country
3 Tariffs Imports tariffs Other instruments specific tariff: (a monetary sum that must be paid to import 1 physical unit of a product)Advantage: easy to collectDisadvantage: doesn’t take price changes into accountad valorem tariff: (a percentage of the monetary value of 1 unit of import)Advantage: takes price changes into accountDisadvantage: Need to know the monetary value of the good and seller is tempted to undervalue the priceOther instrumentsImport subsidy negative import tariffExport tariff/subsidy (levied/paid on home-produced goods that are destined for export)
4 Features of Tariff Schedules Preferential dutiesproducts form certain countries are subject to lower tariffs than the normal tariff rateGeneralized System of Preferences (GSP) for developing countriesMost-favoured-nation (MFN) treatment = normal trade relations (NTR)“if country A grants country B the status of most-favoured nation, it means that B’s exports will face tariff that are no higher (nor lower) than those applied to any other country that A calls a MFN” (Economics A-Z in The Economist website)
5 Non-tariff Barriers to Trade (1) Import Quotasa government agency allocates the rights to importlimits the number of goods (not the price) for a given time period“Voluntary” export restraints (VER)foreign suppliers agree to “voluntary” refrain from sending some exportsGovernment procurement provisionsrestriction on purchasing foreign products by the domestic government agenciesDomestic content provisionsa given percentage of the value of a good must consist of domestic components or labour
6 Non-tariff Barriers to Trade (2) Administrative classificationdifferent tariffs to different product categories + leeway for customs officials to decide on classificationRestrictions on services tradeTrade-related investment measuresDomestic policies affecting tradehealth, environment and safety standards; packaging and labeling requirements; inconsistent treatment of intellectual property rights; subsidies to domestic firms...etc.
7 Impact of Trade Policy: Levels of Study Partial Equilibrium analysisanalysing one market and ignoring the subsequent or secondary effectsGeneral equilibrium analysisanalysing all markets simultaneously (but still holding technology, endowments etc. constant)Note that here “market” means a market for one good (which can be sold in many countries). We will use both approaches to study one-country and two-country cases. The difference is that in general equilibrium analysis we take also into account what happens in the markets of goods not subject to trade policy.
8 Consumer and Producer Surplus Price (P)In a partial equilibrium approach we can use the concepts of consumer and producer surplusBoth reflect the fact that there is only one market priceHence, there are consumers who would have been willing to pay more for the productSimilarly, all but the “last” unit is produced with lesser marginal cost than the market price receivedS =marginal costof productionconsumersurplusPproducersurplusDQuantity (Q)
9 The Impact of Import Tariff: The Small-Country* Case * Small country = cannot affect world pricesIncrease of producer surplus andgovernment incomeLoss of consumer surplusSDSDPP(1+τ)Pint(1+τ)Pintincrease ofproducersurplustariff to thegovernmentLoss of consumer surplusdeadweightlossdeadweightlossPintPintDDDDQimports after tariffQimports after tariffimports in free tradeimports in free trade
10 The Impact of Import Tariff: The Small-Country Case Introducing a tariff→ Domestic price increases→ Domestic quantity supplied increases→ Domestic quantity demanded falls→ Increase of government revenuesDistributional effectsurplus is transferred from the consumers to the producers and the governmentConsumers lose more than producers and government win: deadweight loss
11 The Impact of Import Quota: The Small-Country Case For every quota there is an equivalent tariff (and for every tariff there is an equivalent quota)The changes in consumer and produce surplus are equivalent to that of a tariffHowever, the increase of government revenue may be lost (depending on how the quotas are allocated)SDPPQPintDDquotaQimports in free trade
12 The Impact of Subsidy to Import-Competing Industry (Small Country Case) SDSDPPincrease ofproducersurplusCost to the governmentefficiencylossPPDDDDimports after the subsidyQimports after the subsidyQimports in free tradeimports in free trade
13 The Impact of Subsidy to Import-Competing Industry (Small Country Case) Equivalent subsidy = producers are subsidised to produce the same amount as they would under a tariff→ Equal increase in the producer surplus as under tariffs→ Large cost to the government→ No impact on price no impact on consumer surplusCost to the government is larger than the increase of producer surplus, i.e. there is a loss of efficiencyHowever, this cost is less than the loss of consumer surplus in the tariff/quota case → subsidies are more efficient than tariffs/quotas
14 Large country, partial equilibrium Single Market, Two Countries Country BCountry APPSASBDBDAQQ
15 Single Market, Two Countries Country BCountry APPSASBDBDAQQCountries A and B have different supply curves (cost of production) and demand curves (preferences). In free trade equilibrium the world price is such that country B is willing to export the same quantity as country A is willing to import.
16 Single Market, Two Countries, Tariff Country BCountry APPSASBDBtariffDAQQPrice in Country A = Price in country B + tariff. If the price in country B would remain constant after a tariff is set, country B would be willing to export more that country A would be willing to import → price in country B must decrease (next slide)
17 Effect of a Tariff in a Single Market and Two-Countries Country BCountry APPDASADBSBPAeaDbtariffPFTprice decrease in country BCPBQQCountry A:Loss of consumer surplus = e+a+D+b; increase of producer surplus = e; Increase of government revenue = C+D. Gain for Country A = gains–losses = (e+C+D)-(e+a+D+b) = C – a – b. That is, if C > a + b country A has gained from the imposition of the tariff (due to lower prices of imports before tariff).
18 Impact of Elasticises Country B Country A P P DA SA SB DB e a D b C Q PFTtariffeaDbprice decrease in country BCPBQQThe more elastic in the exporting market and the more inelastic in the importing market supply and demand are, the less chances the importing country has on gaining from tariff
19 The Impact of Import Quota Graphically identical to the case of tariffThe difference is in, who gets areas D (country A’s government revenue from the tariff) and C (loss of country B’s producer surplus that is transferred to country A in the tariff setting)Voluntary export restraints (VER) can be seen as a way for the exporting country to capture areas C and DThen, if this gain is greater than the deadweight loss of the exporter (triangles around C), the exporting country will gain from the quota
20 General Equilibrium Analysis Partial Equilibrium analysisanalysing one market and ignoring the subsequent or secondary effectsGeneral equilibrium analysisanalysing all markets simultaneously (but still holding technology, endowments etc. constant)Note that here “market” means a market for one good (which can be sold in many countries). We will use both approaches to study one-country and two-country cases. The difference is that in general equilibrium analysis we take also into account what happens in the markets of goods not subject to trade policy.
21 General Equilibrium Effects of a Tariff for a Small Country Import tariff on good Y changes the price ratioProducers adjust from point PFT to PtSince the tariff doesn’t change world prices, country’s real income changes to (PX/PY)tConsumers maximize given domestic prices and real income and move to a lower utility levelNote that real income is determined by the world pricesGood YCFTCtPtPX/(1+τ)PYPFT(PX/PY)t(PX/PY)FTCtPtCFTPFTGood X
22 General Equilibrium Effects of a Subsidy for a Small Country Good YAssume the government subsidizes producer of good Y to impose the same production pattern as with the tariffThe real income of the country remains the sameConsumers face world prices and are able to consume at a higher utility levelCFTCSPSPX/(1+τ)PYPFT(PX/PY)FTCSPSCFTPFTGood X
23 Terms of Trade Effect of a Tariff Imposing a tariff shifts offer curve inwards (the country is now willing to trade less for all terms of trade)→ The tariff imposing country’s terms of trade improve (the price of exports decrease), which may offset the, at least in part, the decrease of welfare due to efficiency loss(PX/PY)E’= TOTE’(PX/PY)E= TOTECountry 2’s offer curveImports to country 1exports from country 2Good Y:Country 1’s offer curveGood X:Exports from country 1Imports to country 2
24 Terms of Trade Effect of a Quota Country 1 sets a quota for imports of good Y→ country 1’s offer curve becomes horizontal at the quota level→ Country 1’s terms of trade improve(PX/PY)E’= TOTE’(PX/PY)E= TOTECountry 2’s offer curveImports to country 1exports from country 2Good Y:Country 1’s offer curveGood X:Exports from country 1Imports to country 2
25 Terms of Trade Effect of a Voluntary Export Restraints Country 2 uses voluntary export restraints (VER) to limit exports of good Y→ country 2’s offer curve becomes horizontal→ country 2’s terms of trade improve(PX/PY)ECountry 2’s offer curve(PX/PY)E’Imports to country 1exports from country 2Good Y:Country 1’s offer curveGood X:Exports from country 1Imports to country 2
26 Other Effects of Protection Restricting imports is likely to result decrease of exports as wellReallocation of domestic resourcesRetaliation by the trading partnersDistributional EffectsTransfer from the consumers to the import-competing producersHO-model: transfer from the abundant factor to the scarce factor