Carbaugh, Chap. 5 1 Why restrict trade? Benefits of free trade in final goods are spread widely Tariffs on intermediate inputs tend to be low Costs of free trade are felt rapidly by domestic producers Costs are usually concentrated in specific sectors

Carbaugh, Chap. 5 2 Flavors of tariffs Tariff: a tax (duty) on internationally traded products Import tariff - levied on imports Export tariff - levied on exported goods as they leave the country … unconstitutional in US Protective tariff - insulate domestic producers from competition Revenue tariff - raise funds for government Tariffs

Carbaugh, Chap. 5 3 Specific tariff Fixed $ / unit Ad valorem tariff % of products value Levied free-on-board (FOB) as it leaves port Levied cost-insurance-freight (CIF) as it arrives in port Compound tariff Combination of fixed and ad valorem tariffs Levied on finished goods whose imported inputs are also subject to tariff Fixed portion offsets tariffs on raw materials paid by domestic producers % portion protects domestic producers against finished good imports Tariffs

Carbaugh, Chap. 5 4 Effective rate of protection For a finished good, Effective tariff rate = {Nominal tariff – (% value Imports)x(Tariff on Imports)} (% Domestic Value Added) The impact of a tariff is often different from its stated amount Tariff Escalation: If domestic value added (domestic content) is low and tariffs on imports are also low Effective tariff >> Nominal tariff. Tariffs

Carbaugh, Chap. 5 5 Nominal and Effective Tariff Rates (US and Japan, early 1980s) USJapan Nominal EffectiveNominal Effective Agriculture, fish, forest. 1.8% 1.9% 18.4% 21.4% Food, beverages,tobacco Footwear Furniture Leather products Paper and paper products Textiles Wearing apparel Wood products

Carbaugh, Chap. 5 6 Avoiding and postponing tariffs Production sharing special treatment for foreign assembly using domestic inputs OAP: Offshore Assembly Provision Maquiladoras Bonded warehouses Assemble imported components and reexport duty free If sell domestically, tariff is levied only on imported value Foreign trade zones (FTZ) Tariffs

Carbaugh, Chap. 5 7 Tariff welfare effects Consumer surplus What buyers are willing to pay Minus What they actually pay Producer surplus What producers receive Minus Cost (Minimum amount to induce them to produce a good) Tariffs

Carbaugh, Chap. 5 8 Consumer and producer surplus Tariffs Price ($) A B C DE Demand (maximum price) (actual price) Consumer surplus Total expenditure Price ($) A B C D Supply (minimum price) (actual price) Producer surplus Total variable cost

Carbaugh, Chap. 5 9 Tariff trade and welfare effects Welfare effects of tariffs Small nation model Price ($) SdSd F S d+w E H f G S d+w+t ab c d e g DdDd

Carbaugh, Chap Costs of import restrictions Domestic consumers face increased costs Low income consumers are especially hurt by tariffs on low-cost imports Overall net loss for the economy (deadweight loss) Production effect: output that cost more than it has to (b) Consumption effect: surplus lost from reduced consumption (d) Export industries face higher costs for inputs Cost of living increases Other nations may retaliate, further restricting trade Tariff effects

Carbaugh, Chap Arguments for trade restrictions Job protection Protect against cheap foreign labor Fairness in trade - level playing field Protect domestic standard of living Equalization of production costs Infant-industry protection Political and social reasons