Tariff, partial equilibrium

1
Tariff, partial equilibrium
Countries may restrict trade in several ways. For
example, they may

• Impose a 100 Euro tax per imported computer
  (tariff)
• Impose a 12 tax per imported computer (ad
  valorem tariff)
• Restrict the number of imported computers (quota)
• Subsidize the production of domestically produced
  computers
• Subsidize the export of domestically produced
  computers
• Require a minimum content before a computer may
  be labeled domestically produced
• Prohibit the sale of computers to certain
  countries for safety reasons
• etc.

All of this will affect trade flows in different
ways. We will restrict attention mainly to
tariffs.
2
Tariff, partial equilibrium
We start with a basic partial equilibrium setup
quantity demanded increases and quantity supplied
falls as the price falls.
In autarky, the equilibrium price is p0, with
quantity q0
The price in the world market, however, is equal
to p1
p0
At that price the domestically supplied quantity
equals q1, and the domestically demanded quantity
equals q2.
p1
The difference between these two quantities is
imported from abroad.
imports
q0
q1
q2
3
Tariff, partial equilibrium
Suppose the government wants to help the domestic
suppliers who face a lower price with trade than
in autarky.
One way to do this is by imposing a tariff equal
to T
If this is a small country in the world markets
this raises the domestic price to p1T
As a result the domestically produced quantity
rises to q3, and the domestically demanded
quantity falls to q4.
p1T
p1
imports
The quantity imported from abroad thus falls
q1
q2
q3
q4
4
Tariff, partial equilibrium
We note that the price level has risen from p1 to
p1T, which has increased the quantity of
domestically produced goods from q1 to q3.
The government turns out to be pleased as well
not only has domestic production and
profitability increased, they earn a revenue as
well equal to
p1T
p1
q1
q2
q3
q4
5
Tariff, partial equilibrium
The only party not in support of this policy are
the consumers. They see the price level rise from
p1 to p1T.
This reduces the consumer surplus considerably,
by the area equal to
Indeed, the loss in consumer surplus is so
considerable that the total welfare change is
negative, equal to the deadweight loss
triangles
p1T
p1
q1
q2
q3
q4
6
Tariff, partial equilibrium
Is it possible in this analysis that the total
welfare change is positive, rather than negative?
Yes, it is.
This does not mean that domestic prices will be
lower than p1, since the tariff T has to be paid
for imports (price wedge).
p2T
T
p1
p2
q1
q2
7
Tariff, partial equilibrium
The producers gain the area
The government gains the area
The consumers lose the area
The total welfare change is equal to
-
An omniscient government would set tariffs to
maximize this welfare gain, the optimal tariff
argument, see the sequel.
p2T
p1
p2
q1
q2