3 TariffsDefining tariffsA tariff is a tax (duty) levied on products as they move between nationsImport tariff - levied on importsExport tariff - levied on exported goods as they leave the countryProtective tariff - designed to insulate domestic producers from competitionRevenue tariff - intended to raise funds for the government budget (no longer important in industrial countries)
4 Types of tariff Specific tariff Ad valorem tariff Compound tariff Fixed monetary fee per unit of the productAd valorem tariffLevied as a percentage of the value of the productCompound tariffA combination of the above, often levied on finished goods whose components are also subject to tariff if imported separately
5 Effective rate of protection TariffsEffective rate of protectionThe impact of a tariff is often different from its stated amountThe effective tariff rate measures the total increase in domestic production that the tariff makes possible, compared to free tradeDomestic producers may use imported inputs or intermediate goods subject to various tariffs, which affects the calculation
6 Effective rate of protection (cont’d) TariffsEffective rate of protection (cont’d)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 rateThis is referred to as tariff escalation
7 Tariff welfare effects TariffsTariff welfare effectsConsumer surplusThe difference between the price buyers would be willing to pay and what they actually payProducer surplusThe revenue producers receive above the minimum amount required to induce them to produce a good
8 Consumer and producer surplus TariffsConsumer and producer surplus
9 Who pays for import restrictions? Tariff effectsWho pays for import restrictions?Domestic consumers face increased costsLow income consumers are especially hurt by tariffs on low-cost importsOverall net loss for the economy (deadweight loss)Export industries face higher costs for inputsCost of living increasesOther nations may retaliate, further restricting trade
10 Basic Tariff Analysis 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 SurplusProducer Surplus
11 Basic Tariff Analysis-Small Country Figure 8-5: A Tariff in a Small CountryPrice, PQuantity, QSADDPrice with tariffD2S2BFEGPrice withouttariffS1D1CImports after tariffImports before tariff
12 Tariff trade and welfare effects Welfare effects of tariffsTariff trade and welfare effects
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 countryProducers gain in the importing countryGovernment imposing the tariff gains revenue
14 Basic Tariff Analysis-Large Country Effects of a TariffAssume 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.
15 Basic Tariff AnalysisThe 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.
16 Basic Tariff AnalysisIn the absence of tariff, the world price of wheat (Pw) would be equalized in both countries.With the tariff in place, the price of wheat rises to PT at Home and falls to P*T (= PT – 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.
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 countryProducers gain in the importing country and lose in the exporting countryGovernment imposing the tariff gains revenue
18 Costs and Benefits of a Tariff 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.
19 Costs and Benefits of a Tariff Large country modelPrice, PQuantity, QSD= consumer loss (a + b + c + d)= producer gain (a)= government revenue gain (c + e)PTaD2S2bcdPWS1D1eP*TQT
20 Costs and Benefits of a Tariff Figure 8-10: Net Welfare Effects of a TariffPrice, PQuantity, QSD= efficiency loss (b + d)= terms of trade gain (e)PTbdPWeP*TImports
21 Optimal Tariff Maximize [e- (b + d)] Small Country: Optimal tariff t=0 Large Country: Optimal tariff (to) maximizes the gain from tariffMaximize [e- (b + d)]e-(b+d)tto
22 Other Instruments of Trade Policy Export Subsidies: TheoryExport subsidyA payment by the government to a firm or individual that ships a good abroadWhen 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.
23 Other Instruments of Trade Policy Figure 8-11: Effects of an Export SubsidyPrice, PQuantity, QSDPSSubsidyabcd= producer gain(a + b + c)= consumer loss (a + b)= cost ofgovernment subsidy(b + c + d + e + f + g)PWefgP*SExports
24 Other Instruments of Trade Policy 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.
25 Other Instruments of Trade Policy Figure: Europe’s Common Agricultural ProgramPrice, PQuantity, QSDSupport priceEU price without imports= cost of governmentsubsidyWorld priceExports
26 Other Instruments of Trade Policy Import Quotas: TheoryAn 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.
27 Other Instruments of Trade Policy 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 holdersWelfare analysis of import quotas versus that of tariffsThe 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.
28 Figure 8-13: Effects of the U.S. Import Quota on Sugar Price, $/tonQuantity of sugar,million tonsSupplyDemand= consumer loss(a + b + c + d)= producer gain (a)= quota rents (c)Price in U.S. Market 466a8.456.32bcdWorld Price 2805.149.26Imposing a tariffof 186Import quota:2.13 million tons
29 Equivalence between tariff and quota Both are equivalentExcept that tariff rents accrue to govt. and Quota rents to license holdersIfP.C in domestic marketCompetitive foreign supplyQuota allocated to ensure P.C among quota holders
30 Other Instruments of Trade Policy Voluntary Export RestraintsA 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.
31 Other Instruments of Trade Policy 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.
32 Arguments for trade restrictions Reasons for tariffsArguments for trade restrictionsJob protectionProtect against cheap foreign laborFairness in trade - level playing fieldProtect domestic standard of livingEqualization of production costsInfant-industry protectionPolitical and social reasons
33 Politics of protectionism Reasons for tariffsPolitics of protectionism“Supply” of protectionism (trade policy) depends on:the cost to society of restricting tradethe political importance of the import-competing industriesMagnitude of the adjustment costs from free tradePublic sympathy for those sectors hurt by free trade
34 Politics of protectionism Reasons for tariffsPolitics of protectionism“Demand” for protectionism depends on:The amount of the import-competing industry’s comparative disadvantageThe level of import penetrationThe level of concentration in the affected sectorThe degree of export dependence in the sector