Trade Policy:

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Trade Policy

• Large Country Case

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Demand for Imports Schedule

• The demand for imports can be derived as the
  excess demand for the good at home
• In autarky equilibrium (P0), home supplyhome
  demand, and there are no imports or exports
• If the price falls below P0 , then there will be
  excess demand for the good and it will be imported

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Demand for Imports Schedule

• As the price falls, demand for imports increases
  due to BOTH an increase in demand and a decrease
  in supply, therefore
• the demand for imports curve will be flatter
  (more price elastic) than the domestic demand
  curve
• If the price falls so low that the home suppliers
  stop producing the good, the demand for imports
  will increase as price falls only because demand
  increases, supply cant fall below 0.
• There is therefore a kink in the curve.

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Domestic Excess Demand
5
Demand for Imports
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Supply of Exports Curve

• The supply of exports can be derived as the
  excess supply of the good at home
• In autarky equilibrium (P0), home supplyhome
  demand, and there are no imports or exports
• If the price rises above P0 , then there will be
  excess supply of the good and it will be exported

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Supply of Exports Curve

• As the price rises, supply of exports increases
  due to BOTH an increase in supply and a decrease
  in demand, therefore
• the supply of exports curve will be flatter (more
  price elastic) than the domestic supply curve
• If the price rises so high that the home
  consumers stop demanding the good, the supply of
  exports will increase as price rises only because
  supply increases, demand cant fall below 0.
• There is therefore a kink in the curve.

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Domestic Supply and Demand
Sh
Ph
P3
P2
P1
P0
Dh
Qs1
Q0
Qs3
Qs2
QD2
QD1
0QD3
Qh
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Supply of Exports
SX
P
P3
P2
P1
P0
QX0
QX1
QX2
QX3
QX
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Effect of Specific and Ad Valorem Tariff

• For a large country as the quantity of the good
  sold increases,
• a specific tariff raises the cost of the good
  uniformly because the tariff applies to the
  quantity
• an ad valorem tariff raises the cost of the good
  proportionally to the price. As the quantity
  increases, so does the price
• the supply curve therefore shifts in a parallel
  movement for the specific tariff and has a
  steeper slope with an ad valorem tariff

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Parallel shift due to specific tariff Increase
in slope due to ad valorem tariffLower
international price due to home tariff
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Incidence of the tariff

• When a tax or tariff is imposed, it affects
  prices
• If the fall in home demand from a tariff affects
  the international price, the importers who seem
  to pay the tariff will share the burden with the
  exporting countries
• For a large, country, because the tariff lowers
  the international price, some of the burden of
  the tariff is passed on to exporters
• a large country may increase its welfare by
  imposing a tariff

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Incidence of the tariff

• The home country government receives tariff
  revenue equal to the amount of imports times the
  difference between the international price
  including tariff (Pm2) and home price with the
  tariff (Pm1)
• The loss due to consumer and producer
  inefficiency is the deadweight loss between the
  price WITHOUT the tariff and the HOME country
  price with the tariff
• The loss to the exporter is the the tariff
  revenue paid by exporters, or between the initial
  international price and the new, lower
  international price.

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Incidence of the tariff

• If the cost to the exporting countries (area
  fhij) is greater than the loss due to
  inefficiency (areas a b), the home country
  gains by imposing a tariff.
• For large countries, there is therefore a debate
  about what is the optimal tariff to impose to get
  a maximum gain
• However, if trading partners retaliate by
  imposing their own tariffs, both countries can
  lose
• This type of policy is called beggar my
  neighbour

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• govt tariff revenue is area c area fhij
• deadweight loss is a b
• country A can therefore gain at the expense of
  country B by imposing a tariff

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Import Quota

• Like a tariff, an import quota in a large country
  can depress the international price, as well as
  limit imports and raise the home price
• The import quota can have exactly the same effect
  as an equivalent tariff
• The quota rents (dark area) can be paid to the
  government in the form of licences, or wasted by
  rent-seeking activities
• Note voluntary export restraints (VERS)are
  similar to import quotas, but the exporting
  imposes the limits government receives the
  quota rents

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• Deadweight Loss
• total EFE
• Paid by
• home EGE
• partner GFE

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Export Tax

• An Export Tax increases the price of exports
  (usually ad valorem, tax is a percentage of the
  price)
• The supply of exports shifts up
• In the following diagram, break down the gains
  losses to
• foreign consumers, domestic producers
• home govt.,
• loss due to inefficiency
• total gain or loss at home, total gain or loss
  abroad

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Answer

• Home price with tax Px2, international price with
  tax Px1, home and international price without tax
  Px0
• home producers lose Px0Px2FE
• foreign consumers lose Px0Px1EE
• government gains Px1Px2FE
• gain ? to home Px0Px1EE - GFE

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Export Subsidy

• An export subsidy subsidizes foreign consumers at
  the expense of home consumers
• In this case the home country loses because it
  pushes down the international price and because
  of production and consumption inefficiency
• in the diagram
• Govt pays Px2Px1FE to producers
• of this, Px2Px0GE is transferred to foreign
  consumers
• inefficiency loss is are FEE

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General Equilibrium Effects of a Tariff in a
Small country

• The GE effect of a tariff is to distort relative
  prices within the country
• these new relatives prices determine both
  production and consumption decisions within the
  country
• However, to acquire imports and sell exports, the
  country must trade at the international relative
  prices.

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• With tariff consume at C1 and produce at B1,
  tangent to new prices within country

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