Chapter 14: The Impact of Trade Policies

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Chapter 14 The Impact of Trade Policies
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Analyzing trade policies

• All trade policies affect trade, not surprisingly
• The mechanism for most effects is through the
  market, by affecting prices
• Analysis of trade policies is performed under
  different assumptions about
• type of market - in this chapter, market is
  perfectly competitive, oligopoly markets are
  analyzed in Chapter 16 (if you are interested)
• size of country
• secondary effects on markets beside the market
  for the good directly targeted by trade policy

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Country Assumptions, Types of Analysis

• Small country
• world price is not affected by home countrys
  policy
• Large country
• world price is affected by home countrys policy
• Partial equilibrium analysis
• analyze direct effect on targeted market only,
  all other effects ignored
• General equilibrium analysis
• markets for all goods are analyzed
  simultaneously, in this class, there will be two
  markets
• general equilibrium analysis uses production
  possibility frontier, and offer curves

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Important Note

• For the analysis of the effects of trade policy,
  we start with FREE TRADE, and analyze the effect
  of the specific policy.
• This is different from analysis of trade, where
  the analysis started with autarky, and looked at
  effect of introducing trade into the country.
• Winners and losers from trade policy are those
  who win or lose from distorting the free trade
  patterns through government policy

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Single Market Effect of a Tariff in a Small
Country

• Small country faces a perfectly elastic supply of
  imports at current international price
• This is represented by a horizontal line Pint
• With free trade, the country does not supply
  enough of the good to satisfy domestic demand
  QD0gtQS0 , and must import QD0 - QS0
• When the country imposes a tariff, the
  international price is not affected.
• Therefore, with an ad valorem tariff t the
  domestic price is Pint(1t)
• Consequently a tariff reduces imports to QD1 -
  QS1

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The Single Market Effect of a Tariff in a Small
Country
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Winners and losers from the imposition of a tariff

• To analyze the effect of a tariff on different
  market participants, we need to examine the
  effect of a price change on consumers and
  producers
• Need to understand and measure consumer surplus
  and producer surplus

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Consumer Surplus

• Consumer surplus is the area under the demand
  curve above the market price
• What does it mean?
• the market demand curve measures consumers
  willingness to pay for a particular good. This
  is the maximum price consumers believe a
  particular quantity is worth
• Consumers actually pay the market price
• The difference between the price consumers are
  willing to pay and the price they actually pay is
  a surplus (unpaid for utility) to the consumer

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Consumer Surplus
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Producer surplus

• The area below the market price and above the
  supply curve
• Why?
• the price at which producers are willing to
  supply a particular quantity of a good is
  measured along the supply curve
• the price producers actually receive is the
  market price
• therefore producers are receiving a price greater
  than the minimum they would accept to be willing
  to supply a particular quantity of the good,
• the difference is the producer surplus

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Producer Surplus
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Welfare Effects of a Tariff in a Small Country

• The effect of an increase in price due to a
  tariff can be measured in the following way
• Consumer surplus loss - reduction in area under
  the demand curve, above the price
• Producer surplus gain - increase in area under
  the price and above the supply curve
• Tariff revenue to government - area between the
  pre-tariff and tariff prices, applied to the
  imports with tariff
• Result with perfect competition and no
  externalities, there is a deadweight loss, taken
  from consumer and given to nobody

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Welfare Effects of a Tariff in a Small Country

• Consumer welfare loss
• abcd
• Producer surplus gain a
• Govt tariff revenue c
• Deadweight loss b d

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Example

• In the following graph we can calculate the
• consumer surplus loss
• producer surplus gain
• government tariff revenue
• And find the deadweight loss from the tariff.

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Welfare Effects of a Tariff in a Small Country

• Assume QD0190 QS0100 Pint 5
• QD1160 QS1120 Pint(1t) 6
• The effect of an increase in price due to a
  tariff can be measured in the following way
• Consumer surplus loss 1x1601/2x30 175
• Producer surplus gain 1x100 1/2x 20
  110
• Tariff revenue to government 1x40 40
• Deadweight loss 175 - 110 - 40 25
• NOTE import quota of 40 has same effect as the
  tariff

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Equivalent Subsidy

• Government may provide the same degree of
  protection to suppliers (and increase production)
  with a subsidy as with a tariff
• A subsidy lowers costs to suppliers, shifting the
  supply curve right.
• In this case, the price at home remains at Pint,
  producers receive Pint(1s)
• Producers receive area a, govt pays ab, and
  consumers lose nothing.
• The deadweight loss is only b

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Equivalent Subsidy

• Note
• Supply curves
• should be
• parallel
• b 20x1/2
• 10

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Tariff Effects on Non-homogeneous Goods
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Tariff with Nonhomogeneous Goods

• With nonhomogeneous goods (i.e. winter coats of
  varying quality), the tariff affects both markets
  simultaneously
• First, the tariff raises the price of the
  imported good and therefore decreases the
  quantity demanded
• Second, the increase in the price of the imported
  good causes demand to increase for the
  home-produced substitute (demand shifts right),
  and therefore its price increases

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Tariff with Nonhomogeneous Goods

• Third, the increase in price for the
  home-produced substitute causes an increase in
  demand for the imported good (a shift right of
  its demand curve)
• These movements can be seen on the following two
  graphs...

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The Market for the Domestic Good
Start at d move to e with shift in demand due
to tariff on import
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Domestic Demand for Foreign Good
Start at e, move to c with tariff, then to d with
increase in price of substitute
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The Impact of an Export Tax
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The Effect of an Export Subsidy
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The Derivation of a Countrys Demand for Imports
Schedule
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