1. Tariffs
Chapter 4
Copyright © 2009 South-Western, a division of Cengage Learning. All rights reserved.

2. Tariffs
definition – tax levied on a good when it crosses a national border
import tariff – much more common
export tariff – less common; revenue source
purposes
protective tariff – designed to reduce the amount of imports entering a country; increase sales for domestic producers
revenue generation – designed to generate additional funds for domestic government

3. Types of Tariffs
specific tariff – fixed monetary amount per unit of the imported good
ad valorem tariff – fixed percentage of the value of the imported good
customs valuation – process of determining the value of an imported good
free-on-board (FOB) valuation – tariff applied as product leaves country
cost-insurance-freight (CIF)valuation – tariff applied as product enters country
compound tariff – combines the elements of specific and ad valorem tariffs

4. Tariff Examples by Country and Industry

5. Effective Rate of Protection
nominal tariff rate – based on tariff applied to value of finished product
effective tariff rate – based on tariff applied to finished product and imported inputs
n = nominal tariff rate on final product
a = ratio of value of imported input to value of finished product (prior to tariffs)
b = nominal tariff rate on imported input
(n-ab)
(1-a)
effective rate of protection = e =

6. Effective Rate – 1st Example
(n-ab)
(1-a)
(0)
1-0.8
for this example:
n = $50/($100 + $400) = 0.1 = 10%
a = $400/($100 + $400) = 0.8
b = $0/($400) = 0

7. Effective Rate – 2nd Example
(n-ab)
(1-a)
(0.05)
1-0.8
in this case:
n = $50/($100 + $400) = 0.1 = 10%
a = $400/($100 + $400) = 0.8
b = $20/($400) = 0.05 = 5%

8. Tariff Escalation
tariff escalation – higher tariffs on intermediate and finished goods and lower tariffs on raw materials
incentive for developing nations to expand production of raw materials
disincentive for developing nations to compete in market for finished goods

9. Offshore Assembly Provision (OAP)
outsourcing – aspects of production process occur in another country
low cost, labor intensive products
OAP – tariffs applied only to portion of production occurring in another country
reduces effective tariff rate for domestic consumers
incentive for foreign producers to use U.S. components in production
detrimental to U.S. workers who also produce the same finished goods

10. Dodging Import Tariffs
tariff avoidance – legal method of reducing or eliminating the amount paid in tariffs
example: Brazilian raw sugar shipped to Caribbean and refined there into ethanol then imported to the U.S. duty free
tariff evasion – illegal means of reducing or eliminating tariffs
examples:
false reclassification of products
falsification of country of origin
altering composition of product itself

11. Postponing Import Tariffs
Bonded Warehouse
location maintained by importers ensuring that all customs obligations will be satisfied
goods may be stored for maximum of 5 years
requires inspection by U.S. Customs Service
Foreign-Trade Zone
U.S. site at which foreign merchandise can be imported without immediate payment of duties or tariffs
does not require inspection by U.S. Customs

12. Consumer & Producer Surplus
1) consumer surplus – additional benefit obtained by the buyer of a good
difference between the maximum that the buyer is willing to pay and the actual price
area below demand and above price
2) producer surplus – additional benefit obtained by the seller of a good
difference between the minimum that the seller is willing to accept and the actual price
area above supply and below price

13. Consumer & Producer Surplus (cont.)
When combined, the areas of consumer surplus and producer surplus represent the total welfare to the nation resulting from the sale of this good.

14. Tariff Welfare Effects – Small Nation
Before Trade:
U.S. consumer surplus is area in red.
U.S. producer surplus is area in green.

15. Tariff Welfare Effects – Small Nation
With Free Trade:
Consumer surplus increases by areas a,b,c,d,e,f and g.
Producer surplus decreases by areas a and e.
The overall increase in welfare is b,c,d and f.

16. Tariff Welfare Effects – Small Nation
With Tariff:
c = revenue effect = lost consumer surplus now government rev.
a = redistributive effect = shift from consumer to producer surplus
b + d = deadweight loss = benefits lost to all parties
b = protective effect
d = consumption effect

17. Tariff Welfare Effects – Large Nation
Before Trade:
U.S. consumer surplus is area in red
U.S. producer surplus is area in green.

18. Tariff Welfare Effects – Large Nation
With Free Trade:
Consumer surplus increases substantially.
Producer surplus decreases but to a lesser degree.
The overall increase in welfare is b,c,d and the triangle above.

19. Tariff Welfare Effects – Large Nation
With Tariff:
c + e = revenue effect = consumer surplus now government rev.
a = redistributive effect = shift from consumer to producer surplus
b + d = deadweight loss = benefits lost to all parties
b = protective effect
d = consumption effect above.

20. Tariff Welfare Effects – Large Nation
Revenue Effect:
In this case there are two separate portions:
c = domestic revenue effect = prior U.S. consumer surplus
e = terms-of-trade effect = redistribution of income from foreign nation
area e > (b+d) leads to more domestic welfare

21. Tariff Burdens on U.S. Exporters
cost of inputs: tariffs increase price of imported raw materials thus increasing the price of manufacturing using these materials making U.S. firms less competitive
cost of living: tariffs lead to higher prices for U.S. consumers eventually leading to higher wages for U.S. workers
international repercussions: tariffs decrease exports from other countries decreasing their income and ability to purchase U.S. exports

22. Tariffs and the Poor
tariffs often applied to low price products which represent large share of budgets of low- income households
regressive - poor pay greater tariffs in percentage terms
high end domestic producers compete based on prestige and quality rather than price so these producers do not lobby as much for greater protection from imports

23. Trade Restriction Arguments
job protection
preserve jobs in some industries but decrease employment in others
increased cost to consumer greater than average salary for worker whose job was saved
cheap foreign labor
productivity and cost relevant factors
relevant to labor intensive production only
fairness in trade – level playing field
other nations lack of environmental regulations
response to trade barriers of other nations

24. Trade Restrictions Arguments (cont.)
domestic standard of living
restrictions only improve standard of living at the expense of trading partners
equalized production costs
scientific tariff – tariff to offset cost differentials
subsidizes inefficient domestic production
infant industry
short run protection for new domestic industries against developed foreign competition
noneconomic arguments
national defense and cultural considerations

25. Political Economy of Protectionism
protection-biased sector consists of import competing companies, their workers, and suppliers to these industries
free-trade-biased sector consists of exporting industries, their workers and suppliers to these industries
U.S. policy dominated by well organized special interest groups representing producers
consumers generally unorganized and diverse
tariff escalation effect as evidence of this imbalance

26. Supply & Demand of Protectionism
greater supply of protection:
higher cost to society
greater political importance
higher adjustment costs
greater public sympathy
greater demand for protection:
greater comparative disadvantage
greater import penetration
greater domestic concentration
lesser export dependence