CHAPTER FIVE
An Introduction to
International Economics
Second Edition
Trade Restrictions: Tariffs
Dominick Salvatore
John Wiley & Sons, Inc.
1
Examples of Trade
Disputes and Tariffs
2
SPECIALTY STEEL
The United States filed a case with the
World
Trade Organization to challenge anti-
dumping
and countervailing duties China placed
on a
U.S. specialty steel product called grain
oriented flat-rolled electrical steel.
3
COATED PAPER
The United States set combined duties ranging up
to 313.8 percent on coated paper from China. The
duties come after accusations were made that
Chinese paper companies were receiving
government subsidies and selling their goods to the
United States at unfairly low prices.
The paper is used in the printing of corporate
annual reports, high-end catalogues and
magazines, and in other prestigious applications.
4
PLASTIC BOTTLES
Iran, Pakistan and the United Arab Emirates last
month brought to 11 the number of countries
whose plastics exporters now face extra EU tariffs,
worth up to 139.70 Euros per tonne.
The EU already has tariffs in place against China,
India, Indonesia, South Korea, Malaysia, Taiwan
and Thailand to stem imports supplying Europe's
booming soft drinks market.
Reuters 1 Oct 2010
5
Movements away from free
trade
While it is generally accepted that free
trade best enhances societal welfare,
complete free trade is seldom practiced.
This situation generates two questions:
Why is complete free trade seldom practiced?
What are the effects of deviating from free
trade?
This chapter considers the second
question by considering the effects of
employing one common tool of deviating
from free trade – the tariff.
6
Types of tariffs
Import vs. export tariffs
An import tariff is a tax (or duty) on
imported goods or services.
This is the most common form of tariff.
An export tariff is a tax on exported
goods or services.
This is rarely seen in developed countries
but is occasionally practiced in developing
countries to generate government revenue.
7
Types of tariffs
Import vs. export tariffs
Ad valorem tariff
A fixed percentage tax on the traded
commodity.
8
Types of tariffs
Import vs. export tariffs
Ad valorem tariff
Specific tariff
A fixed sum tax per unit of a traded
commodity.
9
Types of tariffs
Import vs. export tariffs
Ad valorem tariff
Specific tariff
A compound tariff
A combination of an ad valorem and
specific tariff.
10
Types of tariffs
Import vs. export tariffs
Ad valorem tariff
Specific tariff
A compound tariff
Tariff rates
The U.S. International Trade
Commission provides a searchable
index of tariff rates.
WWW link
11
Small vs. large
The implications of interfering with
trade differ depending on the
nature of the country.
The key distinction is between whether
the country is “small” or “large.”
12
Small vs. large
The implications of interfering with trade
differ depending on the nature of the
country.
A “small” country is one where changes
in its domestic market do not alter the
international price of the commodity.
In the case of a tariff, this means that the
imposition of a tariff does not alter the
international price.
In other words, the country acts as a “price-
taker” in the international market.
13
Small vs. large
The implications of interfering with trade
differ depending on the nature of the
country.
A “small” country is one where changes in
its domestic market do not alter the
international price of the commodity.
A “large” country is one where changes
in its domestic market do alter the
international price of the commodity.
In the case of a tariff, this means that the
imposition of a tariff does alter the
international price.
14
Effects of a tariff: small
country
The effects of a 120
tariff are easily 110
100 Supply
seen in a market
90
supply and 80
demand diagram. 70
In this market, the 60
autarky 50
40
equilibrium occurs 30
a price of $50 and 20
quantity of 50. 10
Demand
0
0 10 20 30 40 50 60 70 80 90 100 110 120
15
Effects of a tariff: small
country
In this market, if the 120
international price is 110
$20, the country will 100 Supply
be an importer of the 90
item. 80
Domestic production 70
will fall from 50 to 20. 60
50
Domestic
40
consumption will rise
30
from 50 to 80. International
20 price
These changes
10
generate imports of 0
Demand
60 units. 0 10 20 30 40 50 60 70 80 90 100 110 120
16
Effects of a tariff: small
country
If a 50% ad valorem 120
tariff is placed on 110
imports, the domestic 100 Supply
price rises from $20 90
(the international 80
price) to the tariff 70
price of $30. 60
Domestic production 50
increases from 20 to 40
Tariff
30. 30 price
Domestic 20
consumption falls 10
Demand
from 80 to 70. 0
0 10 20 30 40 50 60 70 80 90 100 110 120
Imports fall to 40.
17
Effects of a tariff: small
country
The final effect is 120
that the 110
100 Supply
government will
90
begin collecting 80
tariff revenue in 70
this market. 60
The amount of the 50
revenue is $10 x 40
Tariff
40 = $400 per 30 price
20
unit of time.
10
Demand
0
0 10 20 30 40 50 60 70 80 90 100 110 120
18
Welfare effects: small
country
To show the welfare changes from the
tariff the concepts of consumer and
producer surplus must be considered.
Consumer surplus is the difference
between what consumers are willing to
pay for a specific amount of a
commodity and what they actually pay
for it.
Graphically, consumer surplus is the area
under the demand curve and above the
price paid on every unit purchased.
19
Welfare effects: small
country
To show the welfare changes from the
tariff the concepts of consumer and
producer surplus must be considered.
Producer surplus is the extra
payment received by producers above
what needed to have been paid to
cause them to produce the
commodity.
Graphically, producer surplus is the area
below the price received and above the
supply curve on every unit sold.
20
Welfare effects: small
country
Consumer surplus 120
at autarky is given 110
by the indicated 100 Supply
region. 90
When the nation 80
moves to free trade 70
this surplus 60
increases. 50
The imposition of a 40
Tariff
30
tariff reduces this price
surplus by the 20
10
difference between Demand
the international 0
0 10 20 30 40 50 60 70 80 90 100 110 120
and the tariff price.
21
Welfare effects: small
country
Producer surplus at 120
autarky is given by 110
the shaded region. 100 Supply
90
Opening the
80
economy to free 70
trade reduces the 60
surplus to the 50
smaller shaded 40
Tariff
region. 30 price
20
Imposing a tariff
10
increases the 0
Demand
producer surplus. 0 10 20 30 40 50 60 70 80 90 100 110 120
22
Welfare effects: small
country
The losses and 120
gains from the 110
100 Supply
imposition of a
90
tariff exist in the 80
shaded region. 70
The entire region 60
is lost consumer 50
40
surplus. 30
Tariff
price
The dollar value of 20
this region is ($10 10
Demand
x 70) + (½ x $10 x 0
10) or $750. 0 10 20 30 40 50 60 70 80 90 100 110 120
23
Welfare effects: small
country
The entire region is 120
lost consumer 110
100 Supply
surplus.
90
Of this, the 80
portion above the 70
supply curve is 60
gained by 50
40
producers. 30
Tariff
price
The dollar value of 20
this region is ($10 10
Demand
x 20) + (½ x $10 x 0
10) or $250. 0 10 20 30 40 50 60 70 80 90 100 110 120
24
Welfare effects: small
country
The entire region is 120
lost consumer 110
surplus. 100 Supply
Of this, the portion 90
above the supply 80
curve is gained by 70
producers. 60
50
The rectangular
40
area is gained by 30
Tariff
the government as 20
price
tariff revenue. 10
The dollar value of 0
Demand
this region is $10 x 0 10 20 30 40 50 60 70 80 90 100 110 120
40 or $400.
25
Welfare effects: small
country
This leaves a net 120
welfare loss to society 110
of the two triangular 100 Supply
shaded regions. 90
These regions are 80
known as the 70
deadweight loss of a 60
tariff.
50
These have a dollar
40
value of $750 - $250 Tariff
(gained by producers) 30 price
- $400 (gained by the 20
government) or $100. 10
Demand
0
0 10 20 30 40 50 60 70 80 90 100 110 120
26
Effects of a tariff: large
country
120
The effects of a tariff110
on a large country 100 Supply
differ from that in a 90
small country 80
because the 70
60
imposition of a tariff
50
results in a fall in 40
import demand that 30
lowers the
International
20 price
international price. 10 Demand
This is known is as 0
0 10 20 30 40 50 60 70 80 90 100 110 120
the terms of trade
effect. 27
Effects of a tariff: large
country
120
In this case, the 50%110
tariff results in a 100
Supply
drop of the 90
international price 80
from $20 to $15. 70
60
This takes the tariff
50
price to $22.50 per
40
unit.
30
The effects of this International
price
20
change are more 10
Demand
clearly seen through 0
a narrowing of focus 0 10 20 30 40 50 60 70 80 90 100 110 120
in the graph. 28
Effects of a tariff: large
country
40
With the tariff and
improvement in the
terms of trade, 30
production rises
from 20 to 22.5
20
units.
Consumption falls
from 80 to 77.5 10
units.
Imports fall from 60
0
to 55 units. 10 20 30 40 50 60 70 80 90
29
Welfare effects: large
country
40
Consumer surplus
declines by the
shaded region. 30
This has a dollar
value of ($2.50 x
77.5) + (½ x $2.50 x 20
2.5) = $196.875
10
0
10 20 30 40 50 60 70 80 90
30
Welfare effects: large
country
40
Consumer surplus
declines by the shaded
region. 30
Producer surplus
increases by the 20
shaded region
offsetting part of the
consumer loss. 10
This has a dollar
value of ($2.50 x 20)
+ (½ x $2.50 x 2.5) =0
10 20 30 40 50 60 70 80 90
$53.125
31
Welfare effects: large
country
40
Consumer surplus
declines by the shaded
region. 30
Producer surplus
increases by the 20
shaded region
offsetting part of the
consumer loss. 10
Government revenue
increases by $10 x 55
0
or $550. 10 20 30 40 50 60 70 80 90
32
Welfare effects: large
country
40
The net effect is a
welfare gain.
Consumer surplus 30
falls by $196.875
Producer surplus
20
rises by $53.125
Government revenue
increases by $550 10
This generates a net
gain of $300 for this
case. 0
10 20 30 40 50 60 70 80 90
33
Welfare effects: large
country
40
This result arises as
the improvement in
the terms of trade 30
more than offsets the
potential deadweight
20
loss of the tariff.
Welfare lost
Welfare gained 10
0
10 20 30 40 50 60 70 80 90
34
Optimum tariff
The previous example demonstrates that
it is possible for the imposition of a tariff
in a large county to improve societal
welfare.
An optimal tariff is the tariff rate that
maximizes the benefit resulting from the
imposition of a tariff.
The gain comes from the improvement in the
terms of trade.
Positive welfare gains are always possible
from tariff imposition in large countries.
35
A concern about the
optimal tariff
By itself, the existence of an
optimum tariff appears to be a
strong argument for interfering with
free trade.
It is important to note that the
positive welfare gains exist only if no
retaliation in other markets occurs
following the imposition of a tariff.
History does not support the no
retaliation assumption.
36
Nominal tariffs vs. effective
protection
The nominal tariff is the percentage
increase in the price of the final
commodity.
A 50% ad valorem tariff raises the
price of the commodity by 50%
generating a 50% nominal tariff.
37
Nominal tariffs vs. effective
protection
The nominal tariff is the percentage
increase in the price of the final commodity.
The effective rate of protection is
calculated on the increase in domestic
value added offered by tariff protection.
The effective rate of protection offers a
better measure of the protection offered
producers as it takes into account the
cost to producers of tariffs on input
markets.
38
Examples of effective
protection
Suppose a product $12,000
sells for $10,000
but has input costs $10,000
of $5,000 per unit.
$8,000 Value
In this case, its Added
value added is $6,000
$5,000.
The imposition of a $4,000
10% ad valorem Input
$2,000 Cost
tariff raises the
sales price from $0
$10,000 to $11,000. Free Trade
39
Examples of effective
protection
The imposition of a 10% $12,000
ad valorem tariff raises Gain
the sales price from $10,000
$10,000 to $11,000.
Value
This raises the value $8,000 Value
Added
Added
added from $5,000 to
$6,000
$6,000 and offers an
effective rate of $4,000
protection of 20%. Input Input
$1,000 (gain in value $2,000 Cost Cost
added) ÷ $5,000
(original value $0
added) = 20% Free Trade 10% Tariff
40
Examples of effective
protection
Using the starting $12,000
point, assume that
$10,000
a 20% ad valorem
tariff is placed on $8,000 Value
the inputs. Added
This raises the $6,000
input cost from $4,000
$5,000 to $6,000. Input
$2,000 Cost
$0
Free Trade
41
Examples of effective
protection
Using the same example,
$12,000
assume that a 20% ad
valorem tariff is placed on $10,000
the inputs.
Value
This raises the input cost $8,000 Value
Added
from $5,000 to $6,000. Added
$6,000 Loss
This decreases the
value added from
$4,000
$5,000 to $4,000 and Input
Input
offers an effective rate Cost
$2,000 Cost
of protection of - 20%.
- $1,000 (loss in value $0
added) ÷ $5,000 Free Trade 10% Input
(original value added) = Tariff
- 20%
42
Examples of effective
protection
As a final example, $12,000
consider the
$10,000
effective rate of
protection offered $8,000 Value
by combining the Added
previous two $6,000
policies – a 20%
$4,000
tariff on the inputs Input
and a 10% tariff $2,000 Cost
on the final
output. $0
Free Trade
43
Examples of effective
protection
This increases $12,000
Gain
both input cost
$10,000
and final price by Value
$1,000 and leaves $8,000 Value Added
an effective rate of Added
Loss
$6,000
protection of zero.
As is seen, the $4,000
Input
effective level of Input
Cost
$2,000 Cost
protection may
differ greatly from $0
the rate of the Free Trade 10% Input
Tariff
nominal tariff.
44