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International EconomicsInternational Trade(Trade Policy I)

Piero EspositoUniversity of Cassino

University of Cassino

Economics and Business

Academic Year 2021/2022

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Commercial Policy

◼ Policy of tariffs and quotas is called commercial

policy.

◼ There are numerous barriers to trade, some are

obvious (transparent), others are not (non-

transparent).

◼ Two common barriers are Tariffs and Quotas.

Tariffs: indirect limit on imports: impose a tax

on imports.

Quotas: direct limit on imports: regulate the

quantity of imports

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Analysis of a Tariffs and Quotas

◼ Tariffs and quotas encourageConsumers to switch to relatively cheaper

domestic goods.

Domestic producers to increase their output as demand switches from foreign to domestic goods.

◼ We will present a partial equilibrium analysis of the effects of tariffs and quotas: it considers only their impact on the industry on which they are imposed, rather than their economy-wide effects.

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Consumer and Producer Surplus

There are two key concepts in the analysis of the impact of tariffs

Consumer surplus: value received by consumers in excess of the price they pay (can be measured only if the demand curve is known)

Producer surplus: value received by producers in excess of the minimum price at which they are willing to produce (can be measured only if the supply curve is known)

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Diagram of Consumer and

Producer Surplus

Demand

Supply

Price

Quantity

CS

PS

P*

Q*0

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Introducing International Trade

Assume:

1. There is only one price for a good (world

price Pw)

2. Foreign producers are willing to supply us

with all of the units of the good we want at

that price

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Bigger surplus with International

Trade

Demand

Supply

Price

Quantity

CS

PSPw

Q10

Q2

Imports

Domestic

production

P*

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Introducing a Tariff

◼ Now assume: Government imposes a tariff of

amount “t.” Importers will still be able to buy

the good from foreign producers for Pw, but

they will have to pay the import tax of “t.”

The tax is a mark-up onto the price to

domestic consumers. The price to them is

Pw+ t=Pt

The consumption of the imported good

subsequently decreases

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Smaller surplus with the Tariff

Demand

SupplyPrice

Quantity

CS

PSPw

Q*10Q2

ImportsDomestic

production

Pw+t

Revenues

Q*2

Domestic consumption

Protection

lossesshrunk

CS

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◼ In summary, with respect to free trade:

tariffs cause the domestic price to rise by the

amount of the tariff (consumer cost),

domestic consumption falls (consumer cost),

consumer surplus shrinks,

domestic production rises (producer benefit),

imports fall (government benefit),

public revenue increase (government benefit)

→ But total surplus falls.

Results of Tariff Policy

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The Large Country Case

◼ Economists distinguish between small and large

countries in analyzing tariffs:

– Large country: one that imports enough of a

particular product so that if it imposes a tariff,

the exporting country will reduce its price of

the good in order to keep its share of the

large country's market.

◼ In theory, large countries can improve their

national welfare by imposing a tariff as long as

their trading partners do not retaliate.

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When the Large Country imposes a tariff

Demand

Price

Quantity

CS

PSPw*

Q*10Q2

ImportsDomestic

production

Pw*+t

Revenues

Q*2

Domestic consumption

shrunk

CS

Pw

Pw=world pre-tariff price

Pw*+t=post-tariff price

t=tariff

→ Consumer Surplus falls less, Producer Surplus increases less

with respect to the small country case. Import fall less but

revenues increase more

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Effective vs Nominal Rate of Protection

◼ The amount of protection given to any one

product depends not only on the tariff rate but

also on tariffs on the inputs used to produce the

good.

Nominal rate of protection: tariff rate levied

on a given product

Effective rate of protection: nominal rate +

tariffs on intermediate inputs

Value added: price of a good minus the costs

of intermediate goods used to produce it (the

contributions of labor and capital at a given

stage of production)

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Formula of the Effective Rate

of Protection

◼ Effective rate of protection =

(VA* - VA) / VA

VA = amount of domestic value added under

free trade;

VA* = domestic value added after taking into

account all tariffs (on both final goods and

intermediate inputs)

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Example of Nominal and Effective

Rates of Protection

(600-400)/400=50%(300-400)/400=-25%

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Uruguay Round (1986-1995)→WTO

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Less but cascading tariff structure

→The Uruguay Round reduced nominal tariffs, but reduced less

the ‘effective tariffs’ when there is domestic processing.

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The problem of Tariffs

◼ Developed countries often impose tariffs (and

other barriers) that discourage exports of many

developing countries (mainly products of

agriculture, clothing, and textile industries).

◼ The Doha Development Agenda of the World

Trade Organization (WTO) is focused on the

trade problems of developing countries.

◼ Nevertheless, developing countries have higher

tariffs than developed countries.

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Average Tariff Rates, 1986-2010

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Low tariffs in High Income Countries

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Higher tariffs in Less Developed

Countries

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Economic effects of US tariffs

Consumer cost=shrinkage of consumer surplus (CS)

Producer gain=extension of producer surplus (PS)

Deadweight cost=Protection losses

jobs

‘saved’

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US-China bilateral applied tariffs

Source: Brown (2019) The US-China trade conflict. PIIE working paper

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US imports from China covered by

‘special’ protection

Source: Brown (2019) The US-China trade conflict. PIIE working paper

US-China Trade War I

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US-China Trade War

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◼ US tariffs grew

from 3.1% to

19.3% (>6 times!)

◼ Chinese tariffs

increase from 8%

to 20%. (1.5

times)

◼ Higher fall of US

imports

◼ Trade balance vs

China improved

(changed in 2021)

US imports from China

China imports from the US

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Why tariffs?

◼ The higher a country’s income, the lower its tariffs are likely to be. This confirms that trade is beneficial for growth.

◼ But why do developing countries tend to have higher tariff rates?

◼ Because: - tariffs are a relatively easy tax to administer,- instead, on income, sales, and property require more

complex accounting systems,- the informal economy is larger in developing countries,- taxes often form an important part of government revenue.

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Other Potential Costs

◼ A tariff may have effects that are less predictable and harder to quantify

Retaliation by other countries: adds to the net loss of a tariff by hurting export markets of other industries; can escalate rapidly

Innovation: tariffs reduce competitive pressures on domestic firms and thus their incentives to innovate and improve the quality of existing products

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Other Potential Costs of a Tariff (cont.)

Rent seeking: any activity that uses resources

in order to capture more income without actually

producing a good

(e.g., firms hire lobbyists to maintain tariff

protection)

- Political systems that do not easily provide tariffs

are more likely to avoid rent seeking

Exercise

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The figure below represents the case of an open economy with

demand and supply of a tradable good x with world price

pw=7.5, and with a tariff imposed on imports t=2.5.

Calculate:

1) Pre and post-tariff

imports/consumption

2) Pre- and post-tariff

producer surplus

3) Pre- and post-tariff

consumer surplus

4) Government revenue

The End

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