Trade Trade Restrictions:Restrictions:

Tariffs Tariffs

Chapter 8Chapter 8

Introduction

The partial equilibrium effects and general equilibrium effects of a tariff in a small and large country;

The effective rate of protection and the optimum tariff;

The theory of tariff structure.

Key TermsKey TermsAd valorem tariffSpecific tariffCompound tariffConsumption effectProduction effectTrade effectRevenue effectConsumer surplusProducer surplusNominal tariffProhibitive tariffOptimum tariff

Tariff and Its EffectsTariff and Its Effects

A tariff is a tax or duty levied on the traded commodities as they cross national boundaries. An import tariff is a duty on imported commodities, while an export tariff is a duty on exported commodities.

We levy tariff according to the price, the quantity or both. The first is called ad valorem tariff, the second one is called specific tariff and the last one is called a compound tariff.

Effects of a Tariff in a Small Nation

Consumption effect: the reduction in domestic consumption; Production effect: expansion of domestic production resulting from the tariff;

Trade effect: the decline in imports;

Revenue effect: the revenue collected by the government.

But the effect of tariff in a small nation is totally different from the effect of a tariff in a large nation.

Partial Equilibrium Effects of a Partial Equilibrium Effects of a Tariff in a Small NationTariff in a Small Nation

Consumer and Producer Consumer and Producer Surplus in a Small Nation Surplus in a Small Nation

What is consumer surplus?What is consumer surplus?What is producer surplus?What is producer surplus?

What is a, b, c, and d ?

Partial Equilibrium Costs and Partial Equilibrium Costs and Benefits of a Tariff in a Small Benefits of a Tariff in a Small

NationNation

When a small nation imposes a tariff, it will not When a small nation imposes a tariff, it will not

affect world prices. However the domestic price of affect world prices. However the domestic price of

the importable commodity will rise by the amount of the importable commodity will rise by the amount of

the tariff for producers and consumers in the small the tariff for producers and consumers in the small

nation. But for the whole nation, the price remains nation. But for the whole nation, the price remains

the same since the small nation itself collects the the same since the small nation itself collects the

tariff. tariff.

General Equilibrium Analysis of General Equilibrium Analysis of a Tariff in a Small Nationa Tariff in a Small Nation

General Equilibrium Effects of a General Equilibrium Effects of a Tariff in a Small NationTariff in a Small Nation

Tariff inclusive price,So it is parallel to Pf=2

Govt redistri the tariff,So it is parallel to Pw=1

The Stolper-Samuelson The Stolper-Samuelson TheoremTheorem It postulates that an increase in the relative price of a commodity raises the return or earnings of the factor used intensively in the production of that commodity. For example, when nation 2(k-abundant) imposes an import tariff on X, Px/Py rises for domestic producers and consumers and it will raise the real wage of labor because X is labor intensive.

The Stolper-Samuelson theorem is always true for small nations and is usually true for large nations as well. However , for large nation the impact is differ because it affect world prices.

General Equilibrium Analysis of a Tariff in a Large Nation

When a large nation imposes a tariff, its offer curve shifts or rotates toward the axis measuring its importable commodity by the amount of the import tariff. The reason is that for any amount of the export commodity, importers now want sufficiently more of the import commodity to also cover (i.e., pay for) the tariff.

Under these circumstances, imposition of a tariff by a large nation reduces the volume of trade but improves the nation's terms of trade. The reduction in the volume of trade, by itself, tends to reduce the nation's welfare, while the improvement in its terms of trade tends to increase the nation's welfare. Whether the nation's welfare actually rises or falls depends on the net effect of these two opposing forces.

General Equilibrium Analysis of a General Equilibrium Analysis of a Tariff in a Large NationTariff in a Large Nation

General Equilibrium Analysis of a General Equilibrium Analysis of a Tariff in a Large NationTariff in a Large Nation

The relative price of importable commodity X rises for individual consumers and producers in N2, the Stolper-Samuelson theorem holds when we assume that N2 is large.

Only in Exceptional case where Px/Py falls for individual cosumers and producers after nation imposes a tariff, than the theorem will not hold and the w fall in N2 – this is known as Metzler paradox.

Px/ Py=0.625, Py/Px=1/ 0.625=1.6

Optimum Tariff and RetaliationOptimum Tariff and Retaliation

International Trade & the World Economy; Charles van Marrewijk

0

1

2

3

0 1 2 3

export ManufacturesA ; import ManufacturesB

impo

rt Fo

odA ;

expo

rt Fo

odB

offerA no tariff

offerB no tariff

offerA tariff

offerB tariff

C

D

E

F Optimal tariffs and retaliation

Tariff war leads to bad outcome

for all

Conclusions

• There are many different types of trade restrictions

• Imposing tariffs leads to winners (some producers and the government) and losers ( producers abroad)

• Net welfare is negative if the country is ‘small’ (efficiency loss, Harberger triangles)

• Net welfare effect is potentially positive if the country is ‘large’ (= can influence the world relative price level; ‘optimal’ tariff)

• Net welfare effect also negative for large country with retaliation

Effective Rate of ProtectionEffective Rate of ProtectionWe have norminal tariff & effective rate of Protection.

Nominal tariff: it is calculated on the value of the final commodity. It is important to consumers because it indicates the increased price.

Effective rate of protection: it is calculated on the domestic value added that takes place in the nation. It is important to the producers because it indicates how much protection is actually provided to the domestic processing and import-competing commodity.

Example of ERPExample of ERP

Suppose that $80 of imported wool goes into the domestic production of a suit and the free trade price of the suit is $100 but the nation imposes a 10% nominal tariff on each imported suit. The price of suits to domestic consumers would then be $110. Of this, $80 represents imported wool, $20 is domestic value added, and $10 is the tariff.

The $10 tariff collected on each imported suit represents a 10 percent nominal tariff rate since the nominal tariff is calculated on the price of the final commodity (i.e., $10/$100 = 10%) but corresponds to a 50% effective tariff rate because the effective tariff is calculated on the value added domestically to the suit (i.e., $10/$20 = 50%).

Measurement of the ERPMeasurement of the ERP

g=the effective rate of protectiong=the effective rate of protection t=the nominal rate on final commodityt=the nominal rate on final commodity aaii= the ratio of the cost of the imported input to the price = the ratio of the cost of the imported input to the price of the final commodity in the absence of tariffsof the final commodity in the absence of tariffs ttii=the nominal tariff rate on the imported input=the nominal tariff rate on the imported input

i

ii

atatg

1

Formula for effective rate of protection:Formula for effective rate of protection:

t = 10 % or 0.1, ai = $80 / $100 = 0.8, tI = 0

g = 0.1 – (0.8) (0) = 0.1 - 0 = 0.1 =0.5 or 50% 1.0 – 0.8 0.2 0.2

A tariff on imported inputs is a tax on domestic

producers that increases their costs of production,

reduces the rate of effective protection on the final

commodity produced domestically, and therefore

discourages domestic production.

ConclusionConclusion

Chapter 8 Ends