1. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. Chapter 6 The Theory of Tariffs and Quotas

2. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-2 Analysis of a Tariff Quotas: direct limit on imports: regulate the quantity of imports Tariffs: indirect limit on imports: impose a tax on imports Both cause consumers to switch to relatively cheaper domestic good

3. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-3 Consumer and Producer Surplus Consumer surplus: value received by consumers in excess of the price they pay Producer surplus: value received by producers in excess of the minimum price at which they are willing to produce

4. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-4 Prices, Output, and Consumption Assume: 1.There is only one price for a good (world price P w ) 2.Foreign producers are willing to supply us with all of the units of the good we want at that price 3.It’s a small country

5. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-5 TABLE 6.1 Economic Effects of the Tariff in Figure 6.3

6. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-6 A Comparison of Tariff Rates Until Doha round, developing countries have been left out Since mid-90s tariff rates in most countries have fallen Tariff rates in developing nations are higher Developed nations often have highest tariffs in labor-intensive products Prevents developing countries from gaining comparative advantage

7. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-7 FIGURE 6.4 Average Tariff Rates, 1986-2007

8. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-8 Other Potential Costs of a Tariff Retaliation adds to net loss of tariff Innovation diminishes from less competition Rent seeking occurs with protected firms who hire lobbyists to keep protection

9. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-9 The Large Country Case Large country: Tariff will actually decrease the world price of the good. Can improve their national welfare by imposing a tariff as long as there’s no retaliation

10. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-10 Effective versus Nominal Rates of Protection Amount of protection for one product depends on the tariff rate but also on tariffs on the inputs used to produce the good –Nominal rate of protection: tariff rate levied on a given product –Effective rate of protection: nominal rate + tariffs on intermediate inputs –Value added: price of a good minus the costs of intermediate goods used to produce it

11. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-11 Effective vs. Nominal Rates of Protection (cont.) In sum, effective rate of protection = (VA* - VA) / VA Negative tariff rates aren’t uncommon Tariffs aren’t planned in coherent way

12. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-12 TABLE 6.2 Nominal and Effective Rates of Protection

13. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-13 Analysis of Quotas Quota: Restriction that specifies a limit on the quantity of imports Same impact as tariffs, but no government revenue for domestic country Net loss often bigger than with tariffs

14. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-14 Types of Quotas 1 ) Limitation on the quantity of imports 2) Import licensing requirement: importers must obtain government licenses 3) Voluntary export restraint (VER) : the exporting country “voluntarily” agrees to limit its exports for a period

15. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-15 Types of Quotas: VERs VERs have similar effects as quotas, but (1) do not require domestic legislative action (2) Politicians appear as proponents of free trade The use of VERs increased with the decline in tariffs

16. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-16 The Effect on the Profits of Foreign Producers Domestic firms prefer quotas over tariffs because increase in demand increases price Two circumstances that can limit quota rents –If there is a large number of foreign producers, competition may limit their ability to increase prices –The government can extract the extra profits from foreign producers through an auction for import licenses

17. Hidden Forms of Protection Non-tariff measures are hidden, non- transparent forms of protection, such as: - excessively complicated customs procedures, - environmental and consumer health and safety precautions, - technical standards, - government procurement rules Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-17

18. Intellectual Property Rights and Trade There are rules for respecting intellectual property rights as they relate to trade These rules were negotiated during the Uruguay Round (1986-1994) with the Trade Related Aspects Intellectual Property Rights (TRIPS) agreement Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 6-18