The consequences of trade barriers: The Case of an Import Tariff Chapter 8: Analysis of a Tariff

Objectives of the Chapter This chapter analyzes the advantages and disadvantages of tariffs. Except for some recognized exceptional cases, there is a rare consensus among economists that freer trade is better than protectionism. As illustrated in this chapter, economic analysis has consistently demonstrated that there are usually net gains from freer trade for the nation as well as for the world. A tariff helps import substituting producers, and the government collects some tariff revenue (import taxes); however, consumers of the good are unambiguously harmed. Whether or not a tariff will result in a net gain for the importing country will depend on the size of that country. If the country levying the tariff is small (meaning that its actions cannot affect the world price of the good on which the tariff is levied), then the loss to consumers is larger than the sum of gains to producers and to the government. On the other hand, if the country is large (meaning that, by limiting imports, it can force down the world price of the good), then levying a tariff may result in a net gain for the importing country. This will depend upon the portion of the importing countrys government revenues that are, in essence, extracted, or transferred from the foreign country (via its producers) compared to the size of the countrys deadweight losses from the tariff. In any case, the world as a whole always loses from the imposition of a tariff.

After studying Chapter 8 you should be able to identify... - the advantages and disadvantages of a tariff. - how a tariff lowers the welfare of the world as a whole. - ad valorem tariffs versus specific tariffs. - the Effective Rate of Protection (ERP). - how demand supply analysis can be used to assess the gains and losses of a tariff, using both graphical and tabular expositions.

Important Concepts Ad valorem tariff: A tariff that is set as a percentage of a value of a good when it reaches the importing country. Consumption effect: The welfare loss to consumers in the importing nation that corresponds to their being forced to cut their total purchases of a good as a result of the tariff. Deadweight loss: Consumer loss from a tariff that accrues to neither the government nor producers. Effective rate of protection (ERP): The percentage by which the entire set of a nations trade barriers raises the industrys value added (VA) per unit of output. The (Nationally ) Optimum Tariff: A tariff set at the rate that maximizes the gains for a large: country (at the expense of foreign countries). Technically, the optimal rate, as a fraction of the price paid to foreigners, equals the reciprocal of the elasticity of supply of a countrys imports.

Important Concepts Price taking countries: Small countries that cannot affect the world price of the goods and services they trade. In these countries, the import supply curve is infinitely elastic. Production effect: The cost of shifting to more expensive domestic production from an import competing sector that is protected by a tariff on foreign goods. Prohibitive tariff: A tariff set so high that it reduces imports to zero. Specific tariff: A tariff stipulated as a money amount per physical unit of the import. World Trade Organization: An international organization of most of the worlds countries; it oversees governmental policies regarding international trade. The chief purposes of the WTO are to liberalize trade and limit unfair export policies such as subsidies.

Autarky Price - Importing Country

F

F

F

F

= 10 Tariff = 30 Tariff Revenue = c + e e c The Domestic Market price falls (by 3) The World Market price falls (by 3)

F Tariff = = 10 Tariff = 30 = 10

327 = Autarky Price - Exporting Country Autarky Price - Importing Country

327

c Tariff = 30

c Tariff = 30 International Transfer (Foreign to Govt. Importing Country) Welfare Enhancing: Import country Welfare Reducing: Exporting Country Deadweight Losses Importing Country Welfare Neutral Transfer (consumers to Govt.) Importing Country Tariff Income (Govt. Importing Country Deadweight Losses Importing Country

c Tariff = Can be >, <, or = zero Net Welfare Effect (Importing Country) Net Welfare Effect (Exporting Country) * ALWAYS * < zero - * ALWAYS * < zero - Net Welfare Effect (World)

c Tariff = Can be >, <, or = zero Net Welfare Effect (Importing Country) Net Welfare Effect (Exporting Country) * ALWAYS * < zero - * ALWAYS * < zero - Net Welfare Effect (World) If the importing country gains, i.e. if the ToT gain exceeds the deadweight ineffiency losses, then it *MUST* be so that: The Importer gains *LESS* than the Exporter loses!

International Trade Theory Notes

International Trade Theory Notes