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International Economics Trade policies. Classification of Commercial Policy Instruments Commercial Policy Instruments Trade Contraction Trade Expansion.

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Presentation on theme: "International Economics Trade policies. Classification of Commercial Policy Instruments Commercial Policy Instruments Trade Contraction Trade Expansion."— Presentation transcript:

1 International Economics Trade policies

2 Classification of Commercial Policy Instruments Commercial Policy Instruments Trade Contraction Trade Expansion Tariff Export tax Import quota Voluntary Export Restraint (VER) Import subsidy Export subsidy Voluntary Import Expansion (VIE) PriceQuantity PriceQuantity

3 Defining tariffs A tariff is a tax (duty) levied on products as they move between nations Import tariff - levied on imports Export tariff - levied on exported goods as they leave the country Protective tariff - designed to insulate domestic producers from competition Revenue tariff - intended to raise funds for the government budget (no longer important in industrial countries) Tariffs

4 Types of tariff Specific tariff Fixed monetary fee per unit of the product Ad valorem tariff Levied as a percentage of the value of the product Compound tariff A combination of the above, often levied on finished goods whose components are also subject to tariff if imported separately Tariffs

5 Effective rate of protection The impact of a tariff is often different from its stated amount The effective tariff rate measures the total increase in domestic production that the tariff makes possible, compared to free trade Domestic producers may use imported inputs or intermediate goods subject to various tariffs, which affects the calculation Tariffs

6 Effective rate of protection (contd) When tariff rates are low on raw materials and components, but high on finished goods, the effective tariff rate on finished goods is actually much higher than it appears from the nominal rate This is referred to as tariff escalation Tariffs

7 Tariff welfare effects Consumer surplus The difference between the price buyers would be willing to pay and what they actually pay Producer surplus The revenue producers receive above the minimum amount required to induce them to produce a good Tariffs

8 Consumer and producer surplus Tariffs

9 Who pays for import restrictions? Domestic consumers face increased costs Low income consumers are especially hurt by tariffs on low-cost imports Overall net loss for the economy (deadweight loss) Export industries face higher costs for inputs Cost of living increases Other nations may retaliate, further restricting trade Tariff effects

10 Useful definitions: The terms of trade is the relative price of the exportable good expressed in units of the importable good. A small country is a country that cannot affect its terms of trade no matter how much it trades with the rest of the world. Consumer Surplus Producer Surplus Basic Tariff Analysis

11 Figure 8-5: A Tariff in a Small Country S Price, P Quantity, Q D Price with tariff Price without tariff Imports after tariff S1S1 D1D1 Imports before tariff D2D2 S2S2 Basic Tariff Analysis-Small Country A B C F E D G

12 Tariff trade and welfare effects Welfare effects of tariffs

13 Costs and Benefits of a Tariff A tariff raises the price of a good in the importing country and lowers it in the exporting country. As a result of these price changes: Consumers lose in the importing country Producers gain in the importing country Government imposing the tariff gains revenue

14 Effects of a Tariff Assume that two large countries trade with each other. Suppose Home imposes a tax of $2 on every bushel of wheat imported. Then shippers will be unwilling to move the wheat unless the price difference between the two markets is at least $2. Figure 8-4 illustrates the effects of a specific tariff of $t per unit of wheat. Basic Tariff Analysis-Large Country

15 The increase in the domestic Home price is less than the tariff, because part of the tariff is reflected in a decline in Foreign s export price. If Home is a small country and imposes a tariff, the foreign export prices are unaffected and the domestic price at Home (the importing country) rises by the full amount of the tariff. Basic Tariff Analysis

16 In the absence of tariff, the world price of wheat (P w ) would be equalized in both countries. With the tariff in place, the price of wheat rises to P T at Home and falls to P* T (= P T – t) at Foreign until the price difference is $t. In Home: producers supply more and consumers demand less due to the higher price, so that fewer imports are demanded. In Foreign: producers supply less and consumers demand more due to the lower price, so that fewer exports are supplied. Thus, the volume of wheat traded declines due to the imposition of the tariff. Basic Tariff Analysis

17 Costs and Benefits of a Tariff A tariff raises the price of a good in the importing country and lowers it in the exporting country. As a result of these price changes: Consumers lose in the importing country and gain in the exporting country Producers gain in the importing country and lose in the exporting country Government imposing the tariff gains revenue

18 The areas of the two triangles b and d measure the loss to the nation as a whole (efficiency loss) and the area of the rectangle e measures an offsetting gain (terms of trade gain). The efficiency loss arises because a tariff distorts incentives to consume and produce. Producers and consumers act as if imports were more expensive than they actually are. Triangle b is the production distortion loss and triangle d is the consumption distortion loss. The terms of trade gain arises because a tariff lowers foreign export prices (or Home import prices). If the terms of trade gain is greater than the efficiency loss, the tariff increases welfare for the importing country. Costs and Benefits of a Tariff

19 Large country model Costs and Benefits of a Tariff PTPT PWPW P*TP*T b c d e D a = consumer loss (a + b + c + d) = producer gain (a) = government revenue gain (c + e) QTQT D2D2 S2S2 S S1S1 D1D1 Price, P Quantity, Q

20 Figure 8-10: Net Welfare Effects of a Tariff PTPT PWPW P*TP*T b d e D = efficiency loss (b + d) = terms of trade gain (e) Imports S Price, P Quantity, Q Costs and Benefits of a Tariff

21 Optimal Tariff Small Country: Optimal tariff t=0 Large Country: Optimal tariff (t o ) maximizes the gain from tariff Maximize [e- (b + d)] t e-(b+d) toto

22 Export Subsidies: Theory Export subsidy A payment by the government to a firm or individual that ships a good abroad When the government offers an export subsidy, shippers will export the good up to the point where the domestic price exceeds the foreign price by the amount of the subsidy. It can be either specific or ad valorem. Other Instruments of Trade Policy

23 b a Figure 8-11: Effects of an Export Subsidy Other Instruments of Trade Policy PSPS PWPW P*SP*S Price, P Quantity, Q Exports g f e Subsidy d c = producer gain (a + b + c) = consumer loss (a + b) = cost of government subsidy (b + c + d + e + f + g) D S

24 An export subsidy raises prices in the exporting country while lowering them in the importing country. In addition, and in contrast to a tariff, the export subsidy worsens the terms of trade. An export subsidy unambiguously leads to costs that exceed its benefits. Other Instruments of Trade Policy

25 Figure: Europes Common Agricultural Program Other Instruments of Trade Policy Price, P Quantity, Q S D EU price without imports World price = cost of government subsidy Support price Exports

26 Import Quotas: Theory An import quota is a direct restriction on the quantity of a good that is imported. Example: The United States has a quota on imports of foreign cheese. The restriction is usually enforced by issuing licenses to some group of individuals or firms. Example: The only firms allowed to import cheese are certain trading companies. In some cases (e.g. sugar and apparel), the right to sell in the United States is given directly to the governments of exporting countries. Other Instruments of Trade Policy

27 An import quota always raises the domestic price of the imported good. License holders are able to buy imports and resell them at a higher price in the domestic market. The profits received by the holders of import licenses are known as quota rents. They accrue to licenses holders Welfare analysis of import quotas versus that of tariffs The difference between a quota and a tariff is that with a quota the government receives no revenue. In assessing the costs and benefits of an import quota, it is crucial to determine who gets the rents. Other Instruments of Trade Policy

28 Price in U.S. Market 466 World Price 280 b c d Demand a Supply Price, $/ton Quantity of sugar, million tons Figure 8-13: Effects of the U.S. Import Quota on Sugar Import Quota Import quota: 2.13 million tons = consumer loss (a + b + c + d) = producer gain (a) = quota rents (c) Imposing a tariff of 186

29 Equivalence between tariff and quota Both are equivalent Except that tariff rents accrue to govt. and Quota rents to license holders If P.C in domestic market Competitive foreign supply Quota allocated to ensure P.C among quota holders

30 Voluntary Export Restraints A voluntary export restraint (VER) is an export quota administered by the exporting country. It is also known as a voluntary restraint agreement (VRA). VERs are imposed at the request of the importer and are agreed to by the exporter to forestall other trade restrictions. Other Instruments of Trade Policy

31 A VER is exactly like an import quota where the licenses are assigned to foreign governments and is therefore very costly to the importing country. A VER is always more costly to the importing country than a tariff that limits imports by the same amount. The tariff equivalent revenue becomes rents earned by foreigners under the VER. Example: About 2/3 of the cost to consumers of the three major U.S. voluntary restraints in textiles and apparel, steel, and automobiles is accounted for by the rents earned by foreigners. A VER produces a loss for the importing country. Other Instruments of Trade Policy

32 Arguments for trade restrictions Job protection Protect against cheap foreign labor Fairness in trade - level playing field Protect domestic standard of living Equalization of production costs Infant-industry protection Political and social reasons Reasons for tariffs

33 Politics of protectionism Supply of protectionism (trade policy) depends on: the cost to society of restricting trade the political importance of the import- competing industries Magnitude of the adjustment costs from free trade Public sympathy for those sectors hurt by free trade Reasons for tariffs

34 Politics of protectionism Demand for protectionism depends on: The amount of the import-competing industrys comparative disadvantage The level of import penetration The level of concentration in the affected sector The degree of export dependence in the sector Reasons for tariffs


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