International Economics
By Robert J. Carbaugh
9th Edition
Chapter 4:
Tariffs
Copyright ©2004, South-Western College Publishing
Tariffs
Gains from International Trade
According to the free-trade argument, open
markets based on comparative advantage and
specialization result in the most efficient use of
world resources.
Specialization enhance world welfare.
Every nation can overcome the limitations of its
own productive capacity to consume a
combination of goods that exceeds the best it can
produce in isolation.
Carbaugh, Chap. 4 2
Tariffs
Why restrict trade?
Benefits of free trade come in the long
term, and are usually spread widely across
society
Costs of free trade (losses from free trade)
are felt rapidly and are usually concentrated
in specific sectors of the economy
Carbaugh, Chap. 4 3
Tariffs
Defining tariffs
A tariff is a tax (duty) levied on products as
they move between nations
Import tariff - levied on imports
Export tariff - levied on exported goods as they
leave the country
Protective tariff - designed to insulate domestic
producers from competition
Revenue tariff - intended to raise funds for the
government budget (no longer important in
industrial countries)
Carbaugh, Chap. 4 4
Tariffs
Tariff as Revenue
Carbaugh, Chap. 4 5
Tariffs
Types of tariff
Specific tariff
Fixed monetary fee per unit of the
product
• Example: A specific tariff of $10 on
each imported bicycle with an
international price of $100 means
that customs officials collect the
fixed sum of $10.
Carbaugh, Chap. 4 6
Tariffs
Ad valorem tariff
Levied as a percentage of the value of the
product
• Example: A 20% ad valorem tariff on bicycles
generates a $20 payment on each $100
imported bicycle.
Compound tariff
A combination of the above, often levied on
finished goods whose components are also
subject to tariff if imported separately
Carbaugh, Chap. 4 7
Tariffs Types of tariff
Specific
tariff
Compound
Ad-valorem
tariff
tariff
Carbaugh, Chap. 4 8
Tariffs
Effective rate of protection
The impact of a tariff is often different from
its stated amount
The effective tariff rate is an indicator of the
actual level of protection that a nominal
tariff rate provides the domestic import-
competing producers.
Carbaugh, Chap. 4 9
Tariffs Effective rate of protection
One must consider both the effects of tariffs on the final
price of a good, and the effects of tariffs on the costs of
inputs used in production.
Domestic producers may use imported inputs or
intermediate goods subject to various tariffs, which affects
the calculation.
When the tariff on the finished product exceeds the tariff
on the imported input, the effective rate of protection
exceeds the nominal tariff.
If the tariff on the finished product is less than the tariff on
the imported input, the effective rate of protection is less
than the nominal tariff, and may even be negative.
Carbaugh, Chap. 4 10
Tariffs Effective rate of protection (cont’d)
When 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.
This is referred to as tariff escalation
Carbaugh, Chap. 4 11
Tariffs
Avoiding and postponing tariffs (US)
Production sharing and special treatment for foreign
assembly using domestic components
Bonded warehouses
Foreign trade zones
In case of Yemen: still has no a policy for this issue,
though it has been raised several times from many
different manufacturers during the last years.
Carbaugh, Chap. 4 12
Tariffs Costs and Benefits of a Tariff
A tariff raises the price of a good in the importing country
and lowers it in the exporting country. As a result of these
price changes:
Consumers lose in the importing country and gain in
the exporting country
Producers gain in the importing country and lose in the
exporting country
Government imposing the tariff gains revenue
To measure and compare these costs and benefits, we
need to define consumer and producer surplus.
Carbaugh, Chap. 4 13
Tariffs
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
Carbaugh, Chap. 4 14
Tariffs
Consumer and producer surplus
Carbaugh, Chap. 4 15
Tariffs Before explaining the tariff welfare effects
Basic Tariff Analysis should illustrate
Useful definitions:
The terms of trade is the relative price of the exportable
good expressed in units of the importable good.
A small country is a country that cannot affect its terms
of trade no matter how much it trades with the rest of the
world.
The analytical framework will be based on either of
the following:
Two large countries trading with each other
A small country trading with the rest of the world
Carbaugh, Chap. 4 16
Welfare effects of tariffs
Tariff trade and welfare effects
Carbaugh, Chap. 4 17
Welfare effects of tariffs
Tariff trade and welfare effects
Carbaugh, Chap. 4 18
Tariff trade and welfare effects
-The welfare effects of a tariff can be measured by its
protective effect, consumption effect, redistributive effect,
revenue effect, and terms-of-trade effect.
-If a nation is small compared with the rest of the world, its
welfare necessarily falls by the total amount of the protective
effect plus the consumption effect if it levies a tariff on
imports. If the importing nation is large relative to the world,
the imposition of an import tariff may improve its
international terms of trade by an amount that more than
offsets the welfare losses associated with the consumption
effect and the protective effect.
- Because a tariff is a tax on imports, the burden of a tariff
falls initially on importers, who must pay duties to the
domestic government. However, importers generally try to
shift increased costs to buyers through price increases.
Domestic exporters, who purchase imported inputs subject to
tariffs, thus face higher costs and a reduction in
competitiveness. 19
Carbaugh, Chap. 4
Tariff trade and welfare effects
-Although tariffs may improve one nation’s economic
position, any gains generally come at the expense of
other nations. Should tariff retaliations occur, the volume
of international trade decreases, and world welfare
suffers. Tariff liberalization is intended to promote freer
markets so that the world can benefit from expanded
trade volumes and the international specialization of
inputs.
- Tariffs are sometimes justified on the grounds that they
protect domestic employment and wages, help create a
level playing field for international trade, equate the cost
of imported products with the cost of domestic import-
competing products, allow domestic industries to be
insulated temporarily from foreign competition until they
can grow and develop, or protect industries necessary for
national security. 20
Carbaugh, Chap. 4
Tariff effects
Who pays for import restrictions?
Domestic consumers face increased costs
Low income consumers are especially hurt by
tariffs on low-cost imports
Overall net loss for the economy (deadweight
loss)
Export industries face higher costs for inputs
Cost of living increases
Other nations may retaliate, further restricting
trade
Carbaugh, Chap. 4 21
Reasons for tariffs
Arguments for trade restrictions
Job protection
Protect against cheap foreign labor
Fairness in trade - level playing field
Protect domestic standard of living
Equalization of production costs
Infant-industry protection
Political and social reasons
Carbaugh, Chap. 4 22
Reasons for tariffs Politics of protectionism
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.
“Supply by government” of protectionism (trade policy)
depends on:
the cost to society of restricting trade
the political importance of the import-competing
industries
Size of the adjustment costs from free trade
Public sympathy for those sectors hurt by free trade
Carbaugh, Chap. 4 23
Reasons for tariffs
Politics of protectionism
“Demand by the domestic companies and
workers ” for protectionism depends on:
The amount of the import-competing industry’s
comparative disadvantage
The level of import penetration
The level of concentration in the affected
sector
The degree of export dependence in the sector
Carbaugh, Chap. 4 24