Presentation on theme: "Tariff, general equilibrium"— Presentation transcript:
1 Tariff, general equilibrium We consider the situation for a country faced with the production possibility frontier as drawn in the figure below.smallXYpworldAt the given world price pworld it would produce at point Q* and trade at world prices to consume at point C*ppfQ*U*C*
2 Tariff, general equilibrium If the country imposes a tariff, t, on its import good (good X) this rotates the price line for domestic producers clockwise to pworld(1+t)XYpworldpworld(1+t)Q*They will start to produce at point Q2Q2C*U*
3 Tariff, general equilibrium Despite the tariff the country can still trade with ROW at the price pworldXYpworldpworld(1+t)So the income available to the economy is represented by an income line parallel to the initial income line through the new production pointQ*Q2C*U*
4 Tariff, general equilibrium Consumers, like producers, face the price pworld(1+t)XYThey equalize the marginal rate of substitution with the distorted price line along the new income line; a point like C2pworldpworld(1+t)Q*The difference in production and consumption income (domestic prices) representstariff revenueQ2We assume that this is redistributed lump-sum to the consumersC*C2U*U2
5 Tariff, general equilibrium Tariffs result in a double distortion. First, producers change production and thus income.XYpworldpworld(1+t)Welfare U1 at point C1 is still attainable.Second, consumers arealso confronted with distorted prices, which lowers welfare to U2Q*Q2C*C2C1U*U1U2
6 Tariff, general equilibrium Here is an enlargement of the welfare loss arising from the tariffFirst, the production (income) lossSecond, the consumption lossCheck for yourself that the second loss does not arise if a production subsidy is given, rather than a tariff imposed.C2C*C1U*U2U1
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