Dale R. DeBoer

1
An Introduction to International Economics

• Chapter 5 Trade Restrictions Tariffs
• Dominick Salvatore
• John Wiley Sons, Inc.

2
Movements away from free trade

• While it is generally accepted that free trade
  best enhances societal welfare, complete free
  trade is seldom practiced.
• This situation generates two questions
• Why is complete free trade seldom practiced?
• What are the effects of deviating from free
  trade?
• This chapter considers the second question by
  considering the effects of employing one common
  tool of deviating from free trade the tariff.

3
Types of tariffs

• Import vs. export tariffs
• An import tariff is a tax (or duty) on imported
  goods or services.
• This is the most common form of tariff.
• An export tariff is a tax on exported goods or
  services.
• This is rarely seen in developed countries but is
  occasionally practiced in developing countries to
  generate government revenue.

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Types of tariffs

• Import vs. export tariffs
• Ad valorem tariff
• A fixed percentage tax on the traded commodity.

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Types of tariffs

• Import vs. export tariffs
• Ad valorem tariff
• Specific tariff
• A fixed sum tax per unit of a traded commodity.

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Types of tariffs

• Import vs. export tariffs
• Ad valorem tariff
• Specific tariff
• A compound tariff
• A combination of an ad valorem and specific
  tariff.

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Types of tariffs

• Import vs. export tariffs
• Ad valorem tariff
• Specific tariff
• A compound tariff
• Tariff rates
• The U.S. International Trade Commission provides
  a searchable index of tariff rates.
• WWW link

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Small vs. large

• The implications of interfering with trade differ
  depending on the nature of the country.
• The key distinction is between whether the
  country is small or large.

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Small vs. large

• The implications of interfering with trade differ
  depending on the nature of the country.
• A small country is one where changes in its
  domestic market do not alter the international
  price of the commodity.
• In the case of tariff, this means that the
  imposition of a tariff does not alter the
  international price.
• In other words, the country acts as a
  price-taker in the international market.

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Small vs. large

• The implications of interfering with trade differ
  depending on the nature of the country.
• A small country is one where changes in its
  domestic market do not alter the international
  price of the commodity.
• A large country is one where changes in its
  domestic market do alter the international price
  of the commodity.
• In the case of a tariff, this means that the
  imposition of a tariff does alter the
  international price.

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Effects of a tariff small country

• The effects of a tariff are easily seen in a
  market supply and demand diagram.
• In this market, the autarky equilibrium occurs a
  price of 50 and quantity of 50.

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Effects of a tariff small country

• In this market, if the international price is
  20, the country will be an importer of the item.
• Domestic production will fall from 50 to 20.
• Domestic consumption will rise from 50 to 80.
• These changes generate imports of 60 units.

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Effects of a tariff small country

• If a 50 ad valorem tariff is placed on imports,
  the domestic price rises from 20 (the
  international price) to the tariff price of 30.
• Domestic production increases from 20 to 30.
• Domestic consumption falls from 80 to 70.
• Imports fall to 40.

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Effects of a tariff small country

• The final effect is that the government will
  begin collecting tariff revenue in this market.
• The amount of the revenue is 10 x 40 400 per
  unit of time.

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Welfare effects small country

• To show the welfare changes from the tariff the
  concepts of consumer and producer surplus must be
  considered.
• Consumer surplus is the difference between what
  consumers are willing to pay for a specific
  amount of a commodity and what they actually pay
  for it.
• Graphically, consumer surplus is the area under
  the demand curve and above the price paid on
  every unit purchased.

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Welfare effects small country

• Consumer surplus is the difference between what
  consumers are willing to pay for a specific
  amount of a commodity and what they actually pay
  for it.
• Producer surplus is the extra payment received by
  producers above what needed to have been paid to
  cause them to produce the commodity.
• Graphically, producer surplus is the area below
  the price received and above the supply curve on
  every unit sold.

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Welfare effects small country

• Consumer surplus at autarky is given by the
  indicated region.
• When the nation moves to free trade this surplus
  increases.
• The imposition of a tariff reduces this surplus
  by the difference between the international and
  the tariff price.

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Welfare effects small country

• Producer surplus at autarky is given by the
  shaded region.
• Opening the economy to free trade reduces the
  surplus to the smaller shaded region.
• Imposing a tariff increases the producer surplus.

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Welfare effects small country

• The losses and gains from the imposition of a
  tariff exist in the shaded region.
• The entire region is lost consumer surplus.
• The dollar value of this region is (10 x 70)
  (½ x 10 x 10) or 750.

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Welfare effects small country

• The entire region is lost consumer surplus.
• Of this, the portion above the supply curve is
  gained by producers.
• The dollar value of this region is (10 x 20)
  (½ x 10 x 10) or 250.

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Welfare effects small country

• The entire region is lost consumer surplus.
• Of this, the portion above the supply curve is
  gained by producers.
• The rectangular area is gained by the government
  as tariff revenue.
• The dollar value of this region is 10 x 40 or
  400.

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Welfare effects small country

• This leaves a net welfare loss to society of the
  two triangular shaded regions.
• These regions are known as the deadweight loss of
  a tariff.
• These have a dollar value of 750 - 250 (gained
  by producers) - 400 (gained by the government)
  or 100.

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Effects of a tariff large country

• The effects of a tariff on a large country differ
  from that in a small country because the
  imposition of a tariff results in a fall in
  import demand that lowers the international
  price.
• This is known is as the terms of trade effect.

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Effects of a tariff large country

• In this case, the 50 tariff results in a drop of
  the international price from 20 to 15.
• This takes the tariff price to 22.50 per unit.
• The effects of this change are more clearly seen
  through a narrowing of focus in the graph.

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Effects of a tariff large country

• With the tariff and improvement in the terms of
  trade, production rises from 20 to 22.5 units.
• Consumption falls from 80 to 77.5 units.
• Imports fall from 60 to 55 units.

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Welfare effects large country

• Consumer surplus declines by the shaded region.
• This has a dollar value of (2.50 x 77.5) (½ x
  2.50 x 2.5) 196.875

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Welfare effects large country

• Consumer surplus declines by the shaded region.
• Producer surplus increases by the shaded region
  offsetting part of the consumer loss.
• This has a dollar value of (2.50 x 20) (½ x
  2.50 x 2.5) 53.125

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Welfare effects large country

• Consumer surplus declines by the shaded region.
• Producer surplus increases by the shaded region
  offsetting part of the consumer loss.
• Government revenue increases by 10 x 75 or 750.

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Welfare effects large country

• The net effect is a welfare gain.
• Consumer surplus falls by 196.875
• Producer surplus rises by 53.125
• Government revenue increases by 750
• This generates a net gain of 500 for this case.

30
Welfare effects large country

• This result arises as the improvement in the
  terms of trade more than offsets the potential
  deadweight loss of the tariff.
• Welfare lost
• Welfare gained

31
Optimum tariff

• The previous example demonstrates that it is
  possible for the imposition of a tariff in a
  large county to improve societal welfare.
• An optimal tariff is the tariff rate that
  maximizes the benefit resulting from the
  imposition of a tariff.
• The gain comes from the improvement in the terms
  of trade.
• Positive welfare gains are always possible from
  tariff imposition in large countries.

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A concern about the optimal tariff

• By itself, the existence of an optimum tariff
  appears to be a strong argument for interfering
  with free trade.
• It is important to note that the positive welfare
  gains exist only if no retaliation in other
  markets occurs following the imposition of a
  tariff.
• History does not support the no retaliation
  assumption.

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Nominal tariffs vs. effective protection

• The nominal tariff is the percentage increase in
  the price of the final commodity.
• A 50 ad valorem tariff raises the price of the
  commodity by 50 generating a 50 nominal tariff.

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Nominal tariffs vs. effective protection

• The nominal tariff is the percentage increase in
  the price of the final commodity.
• The effective rate of protection is calculated on
  the increase in domestic value added offered by
  tariff protection.
• The effective rate of protection offers a better
  measure of the protection offered producers as it
  takes into account the cost to producers of
  tariffs on input markets.

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Examples of effective protection

• Suppose a product sells for 10,000 but has input
  costs of 5,000 per unit.
• In this case, its value added is 5,000.
• The imposition of a 10 ad valorem tariff raises
  the sales price from 10,000 to 11,000.

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Examples of effective protection

• The imposition of a 10 ad valorem tariff raises
  the sales price from 10,000 to 11,000.
• This raises the value added from 5,000 to 6,000
  and offers an effective rate of protection of
  20.
• 1,000 (gain in value added) 5,000 (original
  value added) 20

Gain
37
Examples of effective protection

• Using the starting point, assume that a 20 ad
  valorem tariff is placed on the inputs.
• This raises the input cost from 5,000 to 6,000.

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Examples of effective protection

• Using the same example, assume that a 20 ad
  valorem tariff is placed on the inputs.
• This raises the input cost from 5,000 to 6,000.
• This decreases the value added from 5,000 to
  4,000 and offers an effective rate of protection
  of - 20.
• - 1,000 (loss in value added) 5,000 (original
  value added) - 20

Loss
39
Examples of effective protection

• As a final example, consider the effective rate
  of protection offered by combing the previous two
  policies a 20 tariff on the inputs and a 10
  tariff on the final output.

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Examples of effective protection

• This increases both input cost and final price by
  1,000 and leaves an effective rate of protection
  of zero.
• As is seen, the effective level of protection may
  differ greatly from the rate of the nominal
  tariff.

Gain
Loss