International Economics

Woraphon Yamaka

Chapter 4:Tariffs

Modified form International Economics 9th Edition byRobert J. Carbaugh

Why restrict trade? Benefits of free trade come in the long term, and

are usually spread widely across society Costs of free trade are felt rapidly and are usually

concentrated in specific sectors of the economy

Carbaugh, Chap. 5

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Tariffs

Defining tariffs A tariff is a tax (duty) levied on products as they move between

nations Import tariff - levied on import goods Export tariff - levied on export goods as they leave the

country

Carbaugh, Chap. 5

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Tariffs

Purpose of Tariff

• Protective tariff -is designed to reduce the amount of imports entering a country, thus insulating import-competing producers from foreign competition

• Revenue tariff - is imposed for the purpose of generating tax revenues and may be placed on either exports or imports.

Types of tariff Specific tariff

Fixed monetary fee per unit of the product

For example the U.S. government of $100 per computer, regardless of the computer’s price. Therefore, if 100 computers are imported, the tariff revenue of the government equals $10,000 (100 x 100 =10,000).

Ad valorem tariff Levied as a percentage of the value of the product

For example Suppose that an ad valorem duty of 2.5 percent is levied on imported automobiles. Therefore, if $100,000 worth of autos are imported, the government collects $2,500 in tariff revenue (100,000x2.5% =2500).

Compound tariff A combination of the above, are often applied to manufactured

products embodying raw materials that are subject to tariffs.

For example a U.S. importer of a television might be required to pay a duty of $20 plus five percent of the value of the television.

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Tariffs

Effective rate of protection5

Tariffs

When some inputs used in producing finished good are imported, the amount of protection given to that good depends not only on the tariff rate applied to desktops, but also on whether there are tariffs on inputs used to produce them

For example : Dell computer : The main point is that when Dell imports some of the inputs required to produce desktops, the tariff rate on desktops may not accurately indicate the protection being provided to Dell.

Thus, there are two types of tariff rate

1) Nominal tariff rate is the tariff rate that is published in the country’s tariff schedule. It applies to the value of a finished product that is imported into a country.

2) Effective tariff rate takes into account not only the nominal tariff rate on a finished product, but also any tariff rate applied to imported inputs that are used in producing the finished product

Effective rate of protection6

n > b Effective rate > nominal rate

n < b Effective rate < nominal rate

Protect domestic final product

Protect raw material goods

Effective rate of protection

Carbaugh, Chap. 5

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Tariffs

When tariff rates are high on raw materials and components, but low on finished goods, the effective tariff rate on finished goods is actually much lower than it appears from the nominal rate

(If the country focuses on free trade, they need to reduce the finished goods tax, but if they apply a higher tax in raw materials(negative effect to domestic goods lower the rate of protection), this will boost the effect of the lower tax on finished goods and thus the effective tariff is actually lower than the country expectation (nominal rate) This is referred to as tariff escalation(pushing down)

more trade openness.

Effective rate of protection8

Tariffs

Likewise, tariff rates are low on raw materials and components, but high on finished goods, the effective tariff rate on finished goods is actually much higher than it appears from the nominal rate

(If the country focuses on trade restriction, they need to increase the finished goods tax, but if they apply a lowertax in raw materials(positive effect to domestic goodshigher the rate of protection), this will drop the effect of the higher tax on finished goods and thus the effective tariff is actually higher than the country expectation (nominal rate) This is referred to as tariff escalation(pushing up) less

trade openness.

Avoiding and postponing tariffs

When a country imposes a tariff on imports, there are economic incentives to dodge(avoid) it.

tariff avoidance, the legal utilization of the tariff system to one’s own advantage in order to reduce the amount of tariff that is payable by means that are within the law.

tariff evasion occurs when individuals or firms evade tariffs by illegal means, such as smuggling imported goods into a country.

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Tariffs

Postponing Tariffs

Avoiding tariffs

• Foreign-Trade Zone (Area of free tariff)If the goods never enter the U.S. marketplace, then no duties are paid on those items. For example, if imported components enter a FTZ, are assembled into a final product, and re-exported abroad, no customs duty is paid.

Tariff Effects: An Overview

The tariff benefits producers in the domestic industry

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Advantage

Disadvantage

Less competitive in the domestic industry low quality product

Domestic buyer faces with expensive goods

Job lost in import sector

The extra cost of whatever products and services that use these imported goods in the production process

Tariff welfare effects

Consumer surplus The difference between the price buyers would be willing

to pay and what they actually pay

Producer surplus The revenue producers receive above the minimum

amount required to induce them to produce a good

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Tariffs

To analyze the effect of trade policies on national welfare, it is useful to separate the effects on consumers from those on producers. For each group, a measure of welfare is needed; these measures are known as consumer surplus and producer surplus.

Welfare = Consumer surplus + Producer surplus

Consumer and producer surplus

Carbaugh, Chap. 5 12

Tariffs

Tariff Welfare Effects: Small-Nation Model

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Welfare effects of tariffs

For a small nation, a tariff placed on an imported product is shifted totally to the domestic consumer via a higher product price. Consumer surplus falls as a result of the price increase. The small nation’s welfare decreases by an amount equal to the protective effect and consumption effect, the so-called deadweight losses due to a tariff.

Tariff Welfare Effects: Small-Nation Model

Carbaugh, Chap. 5 14

This small nation would be a price taker, facing a constant world price level for its import commodity.

domestic supply

shows the supply of autos available to small-nation consumers from domestic and foreign sources combined.

shows the supply of autos available to small-nation consumers from domestic and foreign sources combined with tariffs

At point E is the equilibrium price and quantityAt point F is Free-trade equilibrium ( no tariffs)At point G is protective tariff equilibrium ( imposed tariffs)

Tariffs Welfare effects (small nation)

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scenario Consumer SurplusBefore Trade HBefore Tariffs a+b+c+d+e+f+gAfter Tariffs e+f+g

This change affects the nation’s welfare in a various ways (when use tariffs)1) revenue effect (area c) represents the government’s collections of duty.

This revenue collected form domestic consumers represents the portion of the loss in consumer surplus, but transfer to the government for public sector. There is no welfare loss

2) redistributive effect (area a) is a transfer of income from consumers to producers. Producer can sell more and receive a + b but the cost of producing is b, thus the effect equals area a There is no welfare loss

3) protective effect (area b) It illustrates the loss to the domestic economy resulting from wasted resources used to produce additional autos at increasing unit costs. This increase means that resources are usedless efficiently than they would have been with free trade There is welfare loss

Tariffs Welfare effects

Carbaugh, Chap. 5 16

4) Consumption effect (area d) represents the government’s collections of duty. Thus consumption loss A loss of welfare occurs because of the increased price and lower consumption. There is welfare loss

Consumption effect + protective effect is called “dead weight loss”a real cost to society, not a transfer to other sectors of the economy.

Tariff Welfare Effects: Large-Nation Model

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Welfare effects of tariffs

The support for free trade by economists may appear so pronounced that one mightconclude that a tariff could never be beneficial. However, this is not necessarily true.A tariff may increase national welfare when it is imposed by an importing nationthat is large enough so that changes in the quantity of its imports, by means of tariffpolicy, influence the world price of the product

g

H

Carbaugh, Chap. 5 18

Tariff Welfare Effects: Large-Nation ModelThis large nation would be a price setter, facing a non-constant world price level for its import commodity.

At point E is the equilibrium price and quantityAt point F is Free-trade equilibrium ( no tariffs)At point G is protective tariff equilibrium ( imposed tariffs)

Tariffs Welfare effects (large nation)

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scenario Consumer SurplusBefore Trade H (producer+consumer surplusBefore Tariffs a+b+c+d+gAfter Tariffs G (only producer surplus)

This change affects the nation’s welfare in a various ways (when use tariffs)1) revenue effect (area c+e) represents the government’s collections of

duty. This revenue represents the portion of the loss in consumer surplus, but transfer to the government for public sector. The revenue effect of an import tariff in the large nation includes two components.1.1 domestic revenue effect (area c ) collect form domestic consumer1.2 terms-of-trade effect (area e) collect form foreign producers There is

no welfare loss

Tariffs Welfare effects (large nation

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2) redistributive effect (area a) is a transfer of income from consumers to producers. Producer can sell more and receive a + b but the cost of producing is b, thus the effect equals area a There is no welfare loss3) protective effect (area b) It illustrates the loss to the domestic economy resulting from wasted resources used to produce additional autos at increasing unit costs. This increase means that resources are usedless efficiently than they would have been with free trade There is welfare loss4) Consumption effect (area d) represents the government’s collections of duty. Thus consumption loss A loss of welfare occurs because of the increased price and lower consumption. There is welfare loss

Again area d+b depict the tariff’s deadweight loss

Note : However, notice that the tariff revenue accruing to the government now comes from foreign producers as well as domestic consumers. This result differs from the small nation case in which the supply schedule is horizontal and the tariff’s burden falls entirely on domestic consumers. In addition, Large country has higher market power , thus they can collect some tax form foreign firms

Tariffs Welfare effects

Carbaugh, Chap. 5 21

The conclusions regarding the welfare effects of a tariff are as follows:1. If e > (b+d), national welfare is increased.2. If e = (b+d), national welfare remains constant.3. If e <(b+d), national welfare is diminished.

Consequences of import restrictions

Domestic consumers face increased costsLow income consumers are especially

hurt by tariffs on low-cost importsOverall net loss for the economy

(deadweight loss) Export industries face higher costs for inputsCost of living increasesOther nations may retaliate, further

restricting trade

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Tariff effects

Arguments for trade restrictions

Job protection

Protect against cheap foreign labor

Fairness in trade – domestic and foreign have a fair competition

Protect domestic standard of living

Equalization of production costs

Infant-industry protection

Political and social reasons

Carbaugh, Chap. 5

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Reasons for tariffs

Politics of protectionism

“Supply” of protectionism (trade policy) depends on:

the cost to society of restricting trade

the political importance of the import-competing industries Ex: It is more difficult for politicians to disagree with 1 million autoworkers than with 20,000 copper workers.

Magnitude of the adjustment costs from free trade

Public sympathy for those sectors hurt by free trade

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Other Reasons for tariffs

The political economy of import protection can be analyzed in terms of supply and demand. Protectionism is supplied by the domestic government, while domestic companies and workers are the source of demand

Politics of protectionism “Demand” for protectionism depends on:

The amount of the import-competing industry’s comparative disadvantage

The level of import penetration (market share)

The level of concentration in the affected sector

The degree of export dependence in the sector

Carbaugh, Chap. 5

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Reasons for tariffsOther Reasons for tariffs