 Charles van Marrewijk Tariff, partial equilibrium; 1 Countries may restrict trade in several ways. For example, they may Impose a 100 Euro tax per imported computer (tariff) Impose a 12% tax per imported computer (ad valorem tariff) Restrict the number of imported computers (quota) Subsidize the production of domestically produced computers Subsidize the export of domestically produced computers Require a “minimum content” before a computer may be labeled “domestically produced” Prohibit the sale of computers to certain countries for safety reasons etc. All of this will affect trade flows in different ways. We will restrict attention mainly to tariffs.

 Charles van Marrewijk Tariff, partial equilibrium; 2 We start with a basic partial equilibrium setup; quantity demanded increases and quantity supplied falls as the price falls. q p D S In autarky, the equilibrium price is p 0, with quantity q 0 q0q0 p0p0 The price in the world market, however, is equal to p 1 p1p1 q1q1 q2q2 At that price the domestically supplied quantity equals q 1, and the domestically demanded quantity equals q 2. The difference between these two quantities is imported from abroad. imports

 Charles van Marrewijk Tariff, partial equilibrium; 3 Suppose the government wants to help the domestic suppliers who face a lower price with trade than in autarky. q p D S One way to do this is by imposing a tariff equal to T If this is a small country in the world markets this raises the domestic price to p 1 +T p1p1 q1q1 q2q2 As a result the domestically produced quantity rises to q 3, and the domestically demanded quantity falls to q 4. The quantity imported from abroad thus falls p 1 +T q3q3 q4q4 imports

 Charles van Marrewijk Tariff, partial equilibrium; 4 We note that the price level has risen from p 1 to p 1 +T, which has increased the quantity of domestically produced goods from q 1 to q 3. q p D S p1p1 q1q1 q2q2 The government turns out to be pleased as well; not only has domestic production and profitability increased, they earn a revenue as well equal to: p 1 +T q3q3 q4q4 Thus, the domestic producers support this policy; indeed their profits have increased by the area:

 Charles van Marrewijk Tariff, partial equilibrium; 5 The only party not in support of this policy are the consumers. They see the price level rise from p 1 to p 1 +T. q p D S p1p1 q1q1 q2q2 p 1 +T q3q3 q4q4 This reduces the consumer surplus considerably, by the area equal to: Indeed, the loss in consumer surplus is so considerable that the total welfare change is negative, equal to the “deadweight loss” triangles:

 Charles van Marrewijk Tariff, partial equilibrium; 6 Is it possible in this analysis that the total welfare change is positive, rather than negative? q p D S p1p1 q1q1 q2q2 p 2 +T q3q3 q4q4 Yes, it is.Remember that imposing a tariff reduces the quantity imported from abroad. If this fall in demand has a substantial impact on the rest of the world it will reduce the world price of this good, say from p 1 to p 2 (large country) p2p2 This does not mean that domestic prices will be lower than p 1, since the tariff T has to be paid for imports (price wedge). T

 Charles van Marrewijk Tariff, partial equilibrium; 7 The producers gain the area: q p D S p1p1 q1q1 q2q2 p 2 +T q3q3 q4q4 p2p2 The government gains the area: The consumers lose the area: The total welfare change is equal to: - An omniscient government would set tariffs to maximize this welfare gain, the “optimal” tariff argument, see the sequel.