CHAPTER
8 International Economics
Trade Restrictions: Tariffs
Trade Restrictions: Tariffs
Learning goals: After studying chapter 8, you
should be able to:
Describe the effect of a import tariff and
quotas on consumers and producers
Identify the costs and benefits of a import
tariff on a small and a large nation
Describe an optimum tariff and retaliation
Understand the meaning and importance of
tariff structure
Introduction - Questions
What are the effects of various trade policy
instruments?
Who will benefit and who will lose from these trade
policy instruments?
What are the costs and benefits of protection?
Will the benefits outweigh the costs?
What should a nation’s trade policy be?
Should the Vietnam use a tariff to protect its
automobile industry against competition from Japan
and South Korea?
Slide 8-3
Introduction – Defining Tariffs
A tariff is a tax or duty levied on the traded
commodity as it crosses a national boundary
An import tariff is a duty on the imported
commodity
An export tariff is a duty on the exported
commodity
Introduction – Defining Tariffs
Purposes:
Protective tariff: designed to insulate
domestic producers from competition
Revenue tariff: intended to raise additional
funds for domestic government
Introduction - Types of Tariffs
Specific tariff
is expressed as a fixed sum per physical unit of the
traded commodity
Eg 1:
Eg 2:
Ad valorem tariff
is expressed as a fixed percentage of the value of the
traded commodity
Compound tariff: duty (tariff) is a combination of
an ad valorem and a specific tariff.
Eg 3: A fixed $100 duty plus 10% of the value of every imported car
Partial Equilibrium Analysis of a Tariff
Resulting Effects of Tariff
Consumption effect: Reduction in domestic consumption
Decrease in consumer surplus
Production effect: Expansion of domestic production
Increase in producer surplus
Trade effect: Decline in imports
Revenue effect: Revenue collected by the government
Protection cost, or deadweight loss
Nation 2 is small nation;
FIGURE 8-1 Partial Equilibrium Effects of a Tariff.
Effect of a Tariff on Consumer and Producer
Surplus
Small nation
FIGURE 8-3 Partial Equilibrium Costs and Benefits of a Tariff.
Case study 8-3: The Welfare Effect of Liberalizing Trade
on Some U.S. Products
Assume that the functions of a demand curve and of a
supply curve of a small country M (small economy) for X
are Dx = 130-Px and Sx = -10+Px, Po (price of X before
tariff) = 20 USD; t (import tariff) =25%
1. Draw the graph
2. What is amount of X imported after import tariff?
3. Calculate the increase in producer surplus, decrease of
consumer surplus and government revenue after import
tariff
The Theory of Tariff Structure
The Rate of Effective Protection
Nominal tariff rate: Based on tariff applied to value
of final commodity
Effective tariff rate: Based on tariff applied to final
commodity and imported inputs
.
The Theory of Tariff Structure
The Rate of Effective Protection
Indicates how much protection is actually
provided to domestic producer of import-
competing commodity.
When a nation imposes a lower tariff on
imported inputs than on the final commodity
produced with the inputs, the rate of effective
protection exceeds the nominal tariff rate.
.
The Theory of Tariff Structure
The Rate of Effective Protection
eg: the government imposes cotton duty free
BUT, it imposes 20% tariff on cloth
Purposes:
To encourage domestic processing and
employment
.
The Theory of Tariff Structure
The Rate of Effective Protection
Calculated as follows:
t - aiti
g=
1 - ai
g = rate of effective protection
t = nominal tariff rate on final commodity
ai = ratio of cost of imported input to price of final
commodity with no tariff
ti = nominal tariff rate on imported input
The Theory of Tariff Structure
The Rate of Effective Protection
Calculated as follows:
t - aiti
g=
1 - ai
Conclusions:
If ai = 0, g = t
For given values of ai and ti, g is larger the greater is t
For given values of t and ti, g is larger the greater is ai
The value of g is >, = or < t, as ti <, = or > t
When aiti > t, the rate of effective protection is
negative
The rate of effective protection
Tariff Escalation
Tariff escalation:
higher tariffs on intermediate & finished goods and,
lower tariffs on raw materials
incentive for developing nations to expand production
of raw materials
disincentive for developing nations to compete in
market for finished goods
Salvatore: International Economics, 8th Edition © 2004 John Wiley & Sons, Inc.
Postponing Import Tariffs
Bonded Warehouse:
location maintained by importers ensuring that all
customs obligations will be satisfied
goods may be stored for maximum of 5 years
requires inspection by U.S. Customs Service
Foreign-Trade Zone:
U.S/VN. site at which foreign merchandise can
be imported without immediate payment of
duties or tariffs
does not require inspection by U.S./VN Customs
Trade Restriction Arguments
1) job protection
• preserve jobs in some industries but decrease
employment in others
• increased cost to consumer greater than average
salary for worker whose job was saved
2) cheap foreign labor
• productivity and cost relevant factors
• relevant to labor intensive production only
3) fairness in trade – level playing field
• other nations lack of environmental regulations
• response to trade barriers of other nations
Trade Restrictions Arguments (cont.)
4) domestic standard of living
• restrictions only improve standard of living at the
expense of trading partners
5) equalized production costs
• scientific tariff – tariff to offset cost differentials
• subsidizes inefficient domestic production
6) infant industry
• short run protection for new domestic industries
against developed foreign competition
7) noneconomic arguments
• national defense and cultural considerations
Tariffs have been sharply reduced since
World War II.
Tariffs average 5 percent or less on industrial
products in developed nations, but are much
higher in developing nations.
FIGURE 8-4 Pre- and Post-Uruguay Round Cascading Tariff
Structure in Industrial Countries.
FIGURE 8-5 General Equilibrium Effects of a Tariff
in a Small Country.
General Equilibrium Analysis of a Tariff in a
Small Country
Stolper-Samuelson Theorem
An increase in the relative price of a
commodity (for example, as the result of a tariff)
raises the return of the factor used intensively
in production of the commodity.
Thus, the real return to the nation’s scarce
factor of production will rise with the
imposition of a tariff.
Tariffs in a large economy
A large economy has an effect on world price:
Lower imports lead to lower prices
Larger imports lead to higher prices
Upward-sloping export curve
Foreign supply curve is no longer “infinitely
elastic”
Tariffs lead to an increase in the price of the
good on domestic market, a decrease imports
and lower in the price in the rest of the world
General Equilibrium Analysis of a Tariff in a
Large Country
Under these circumstances, when large Nation
imposes a tariff:
A reduction in trade volume will reduce welfare
An improvement in terms of trade will increase welfare
Whether welfare actually rises or falls depends on net
effect.
Tariffs in a large economy
Consumer loss: - (a+b+c+d)
Producer gain: + a
Tariff revenues: + (c + e) => Net effect on Home = e – (b+d)
Deadweight loss: (b+d)
FIGURE 8-6 General Equilibrium Effects of a Tariff
in a Large Country.
;
FIGURE 8-7 The Optimum Tariff and Retaliation.
Tariff rate, applied, weighted mean, all products (%)
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