Welfare Implications of Trade Barriers

Welfare Implications of Trade Barriers

Chapter 14

Consumer Surplus

• A demand curve represents willingness to pay by demanders

• Demand curves array these different individuals’ preferences in order of their willingness to pay

Consumer Surplus

D

Q

PDemand for Shania Twaintickets (or anything else)is downward-sloping. Those who are most willing to pay appearon the upper part of the curve;those less willing to pay are loweron the curve

Consumer Surplus

D

Q

PSuppose the price of a Shania Twain ticket is P*

P*

Consumer Surplus

D

Q

PSo the first consumer gets a deal:he or she is willing to pay P1, but only has to pay P*

P*

P1

Consumer Surplus

D

Q

PThe first consumer gets a surplusequivalent to the shaded area

P*

P1

Consumer Surplus

D

Q

PThe second consumer is willingto pay a bit less, P2. But he orshe still makes out well, sincethe actual market price is only P*

P*

P2

Consumer Surplus

D

Q

PThe second consumer receives asurplus equivalent to the shadedregion. Each consumer who purchases this product gets a littlesurplus.

P*

P2

Consumer Surplus

D

Q

PAll of the individuals’ surplusescan be added together to form ameasure of consumer well-being.CS is the area between the demandcurve and the price.

P*

Consumer Surplus

• If the price rises, CS gets smaller and consumers are worse off

Consumer Surplus

D

Q

P

P*

Consumer Surplus

D

Q

PIf the price rises to P*

1, CS fallsto the area of the green triangle,reflected diminished consumer well-being

P*

P*1

Consumer Surplus

D

Q

PThe yellow shaded area is theloss in consumer surplus

P*

P*1

Consumer Surplus

• If the price falls, CS gets larger and consumers are better off

Consumer Surplus

D

Q

P

P*

Consumer Surplus

D

Q

PIf the price falls to P*

1, consumer surplus rises. Consumers are betteroff.

P*

P*1

Producer Surplus

• A supply curve arrays suppliers in order according to their marginal costs

• The first firm on the supply curve has the lowest marginal cost, the second firm has the second-lowest marginal cost, etc.

Producer Surplus

S

Q

P

Supply is upward-sloping. Those firms with the lowest MC appearon the lower part of the supplycurve; those suppliers with higherMC are farther up

Producer Surplus

S

Q

PSuppose the market price is P*

P*

Producer Surplus

S

Q

P

So the first supplier gets a deal:he or she is able to charge P*, but only incurs costs of P1

P*

P1

Producer Surplus

S

Q

P

The first supplier receivesa surplus (like profit) equalto the area of the shaded rectangle

P*

P1

Producer Surplus

S

Q

P

When we add together thefirst supplier’s surplus to the second’s (and all the others) we get total producersurplus (PS)

P*

PS is the area between the price and the supply curve.It is a measure of overall well-being of producers

Changes in PS

• PS rises when the price rises

• PS falls when the price falls

Tariffs: A Welfare Analysis• What happens when a country imposes a tariff?

Its domestic price rises• We know from before that tariffs:

– benefit domestic producers

– harm domestic consumers

– generate tariff revenue for the government

• What’s the overall effect on the domestic economy? Could a tariff ever increase a country’s welfare?

Tariffs: A Welfare Analysis

D

Q

P S

$1

Suppose the free trade

price is $1; 1000 units are

imported

1000 2000


D

Q

P S

$1

A 35% tariff raises the price to

$1.35, lowering imports to 500

units$1.35

1000 20001250 1750


D

Q

P S

$1

CS declines by the shaded area

$1.35

1000 20001250 1750


D

Q

P S

$1

We can quantify this: the area

of the rectangle is (1750)*.35

= $612.50 The triangle’s area is

.5(.35)250 = $43.75. Thus we can

calculate total CS loss as $656.25.$1.35

1000 20001250 1750


D

Q

P S

$1

Meanwhile, PS rises by the shaded

area

$1.35

1000 20001250 1750


D

Q

P S

$1

Again, this is quantifiable: the

area of the rectangle is (1000*.35)

= $350. The area of the triangle is

(.5)(250)(.35) = $43.75. The total

gain to producers is $393.75

$1.35

1000 20001250 1750


D

Q

P S

$1

To recap: the loss in CS is bigger

than the gain in PS, so we are

faced with an overall loss

equivalent to the shaded area:

$1.35

1000 12501750 2000


D

Q

P S

$1

Happily, some of this loss is

recaptured in the form of tariff

revenue

$1.35

1000 12501750 2000

Tariff revenue = 500*.35 = $175


D

Q

P S

$1

What remains is called

deadweight loss (DWL): society

is worse off by the area of the

two DWL triangles

$1.35

1000 12501750 2000


D

Q

P S

$1

DWL = (.5)(250)(.35) +

(.5)(250)(.35) = $87.50

$1.35

1000 12501750 2000

Deadweight Loss

• One can calculate DWL by – figuring out the area of the two triangles, or– summing the loss in CS, the gain in PS, and the

gain in tariff revenue

• You should get the same answer either way!

DWL

Loss in CS: -$656.25

Gain in PS: $393.75

Gain in revenue: $175.00

===================

DWL: -$ 87.50

Note: this is the same number we calculated before

Tariffs: Larger Countries

• In the previous analysis, the tariff caused the imposing country’s price to rise by the full amount of the tariff

• This would mean that the imposing country is “small”; if it imposes a tariff, it is unable to affect the world price

• What if a country is not “small”?

Tariffs: Larger CountriesP

Q

P

Q

S

D

S

D

Importing CountryImporting Country Exporting CountryExporting Country

PICA

PECA


Q

P

Q

S

D

S

D


PICA

PECA

PFT


Q

P

Q

S

D

S

D


PFT

Tariff causes price

to rise in imposing

country

Tariff causes price to fall

in exporting country


Q

P

Q

S

D

S

D


PFT

Imports fall Exports fall


Q

P

Q

S

D

S

D


PFT

CS falls


Q

P

Q

S

D

S

D


PFT

PS rises


Q

P

Q

S

D

S

D


PFT

Tariff revenue

is created


Q

P

Q

S

D

S

D


PFT

Revenue paid by

imposing-country

consumers


Q

P

Q

S

D

S

D


PFT

Revenue paid by

exporters


• After we account for the loss in consumer welfare:


Q

P

Q

S

D

S

D


PFT

CS falls


• After we account for:– the loss in consumer welfare, and– the gain in producer welfare


Q

P

Q

S

D

S

D


PFT

PS rises


• After we account for:– the loss in consumer welfare, and– the gain in producer welfare and– the gain in revenue


Q

P

Q

S

D

S

D


PFT


• After we account for:– the loss in consumer welfare, and– the gain in producer welfare and– the gain in revenue,

• We are left with our DWL triangles (as a loss), and part of our tariff revenue box (as a gain)


Q

P

Q

S

D

S

D


PFT

DWLRevenue gain


• It’s possible for a country to improve its welfare if the revenue captured from exporters exceeds the DWL.

• This happens when the imposing country is large, because in that case the imposing country’s price rises by very little and the exporting country’s price falls by a lot.

Import Quotas: Welfare Implications

• Recall that quotas and tariffs can be designed to be equivalent

• The difference is that with quotas the government generally doesn’t collect revenue, holders of the import licenses get the rent

• So the welfare implications of a quota are the same as those of a tariff:

Import Quotas: Welfare Implications

• The quota-imposing country will see CS fall, and PS rise

• The quota-imposing country will see DWL, but also rent

• Overall, the country will be better off if the rent gained from the other country exceeds the DWL; this could happen for larger countries

• Small countries are worse off for quotas

Tariffs vs. Quotas

• If protection is necessary, tariffs may be preferable to quotas since:– rent is not available for all citizens (only

license-holders– tariffs allow for technological advance– quotas encourage inefficient “rent-seeking”

behavior

Voluntary Export Restraints: Welfare Effects

• Similar to tariffs or quotas, VERs raise the domestic price which– lowers CS– raises PS

• Rent, however, is captured by the exporting country

• The imposing country will lose not only the DWL triangles, but also the rent rectangle

Voluntary Export Restraints: Welfare Effects

Bottom line: VERs lower a country’s short run welfare in both the large and the small country cases

Export Taxes: Welfare Implications

• As we know, export taxes cause the price in the imposing (i.e., exporting) country to fall, since some of what had been exported is not anymore

• We’d predict an increase in CS, a decrease in PS, and a gain in revenue

• What is the overall effect?


P

Q

S

D

PFT

Exports


P

Q

S

D

PFT

PET

The export tax causes

the domestic price to

fall, and exports to

decrease

exports


P

Q

S

D

PFT

PET

CS rises by the shaded

area


P

Q

S

D

PFT

PET

PS falls by the shaded

area


P

Q

S

D

PFT

PET

Revenue rises by

the shaded area


P

Q

S

D

PFT

PET

Overall welfare falls

by the DWL triangles


• For the small country, the loss in producer welfare outweighs the gain in consumer welfare and in tax revenue

• Overall, the small country is worse off as a result of imposing the export tax

• What about larger countries?

Export Taxes: Larger CountriesP

Q

P

Q

S

D

S

D


PICA

PECA

PFT


Q

P

Q

S

D

S

D


PFT

ET causes price

to rise in importing

country

ET causes price to fall

in imposing country


Q

P

Q

S

D

S

D


PFT

Imports fall Exports fall


Q

P

Q

S

D

S

D


PFT

CS rises


Q

P

Q

S

D

S

D


PFT

PS falls


Q

P

Q

S

D

S

D


PFT

Tax revenue is generated


Q

P

Q

S

D

S

D


PFT

Tax revenue from

importing country

Tax revenue from

domestic exporters

Export Taxes: Larger Countries

• After we account for:– the loss in producer welfare, and– the gain in consumer welfare and– the gain in revenue,

• We are left with our DWL triangles (as a loss), and part of our tariff revenue box (as a gain)


Q

P

Q

S

D

S

D


PFT

Revenue from

importing country

DWL

Export Taxes: Larger Countries

• It’s possible for a country to improve its welfare if the revenue captured from the importing country exceeds the DWL.

• This happens when the imposing country is large, because in that case the imposing country’s price falls by very little and the importing country’s price rises by a lot.

Export Subsidies

• Export subsidies– increase volume of exports– raise price in exporting country (b/c less is

available on the domestic market)– do not generate revenue, but rather generate

costs to the imposing country government– may lower the world price, if the subsidy-

imposing country is large enough

Export Subsidies: Welfare Effects

• CS falls• PS rises• But there is no revenue; instead cost• Overall, export subsidies are welfare-

diminishing for small countries and for large countries

• There could be long-run gains; there aren’t any in the short run

Welfare Implications of Trade Barriers

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