CHAPTER 7CHAPTER 7

ANALYSIS OF A ANALYSIS OF A TARIFFTARIFF

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The concept of tariff

A tariff is a tax on importing a good service into a country, usually collected by customs officials at the place of entry.

Tariffs come in two main types:

1. A specific tariff is stipulated as a money amount per physical unit of import.

2. An ad valorem (on the value) tariff is a percentage of the estimated market value of the goods when they reach the importing country.

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The effect of a tariff on producers

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The effects of a tariff on domestic producers

Domestic producers gain when the government imposes a tariff on competing imports. They get a higher price for their products, they produce and sell a larger quantity, and they receive more producer surplus.

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The effect of a tariff on consumers

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The effects of a tariff on domestic consumers

Domestic consumers must pay a higher price (for both imported and domestically produced products), they reduce the quantity that they buy and consume, and they suffer a loss of consumer surplus.

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The tariff as government revenue

The government also collects tariff revenue, equal to the tariff rate per unit imported times the quantity that is imported with the tariff in place.

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The net national loss from a tariff

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The net national loss from a tariff

Area d sometimes called the consumption effect of the tariff. The consumption effect of the tariff is the loss of consumer surplus for those consumers who are squeezed out of the market because the tariff “artificially” raises the domestic price, even though foreigners remain willing to sell products to the importing country at the lower world price. Area d is a deadweight loss.

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The net national loss from a tariff

Area b is called the production effect of the tariff. The production effect of the tariff is the loss from using high-cost domestic production to replace lower-cost imports. Area b is also a deadweight loss. Thus, the gains from trade lost by the tariff come in two forms: the consumption effect of area d plus the production effect of area b.

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Deadweight loss

The monetary value of the loss in economic efficiency due to a government policy (for example, a tax, subsidy, quota, price floor, or price ceiling) that causes market prices, supply or demand to differ from their free market equilibrium values.

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The deadweight loss from a tariff

By discouraging some imports that would have been worth more to buyers than the price being paid to cover the foreign seller’s costs

By shifting some production to higher-cost domestic producers

The tariff still has its costs.

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The terms-of-trade effect and a nationally optimal tariff

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The terms-of-trade effect and a nationally optimal tariff

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The terms-of-trade effect and a nationally optimal tariff

Optimal tariff, the tariff rate that makes the net gain to the importing country as large as possible. For a large country, this optimal tariff lies between no tariff and a prohibitively high one. The optimal tariff rate is inversely related to the price elasticity of foreign supply of the country’s imports.

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The terms-of-trade effect and a nationally optimal tariff

The lower the foreign supply elasticity, the higher optimal tariff rate. The more inelastically foreigners keep to supplying a nearly fixed amount to importing country, the more importing can get away with exploiting exporting country. Conversely, if exporting country’s supply is infinitely elastic (the small country case), facing importing country with a fixed world price, then importing country cannot get exporting country to accept lower prices. If exporting country supply elasticity is infinite, importing country’s tariff hurts only themselves, and the optimal tariff is zero.

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The terms-of-trade effect and a nationally optimal tariff

The optimal tariff causes a net loss to the whole world. The loss to the foreign exporting country is larger than the net gain to the importing country. And a country trying to impose an optimal tariff risks retaliation by the foreign countries hurt by the country’s tariff.

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Questions1

Home’s demand curve for wheat is

D=100-20P

Its supply curve is

S=20+20P

Foreign’s demand curve is D*=80-20P, and a supply curve is S*=40+20P.

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Questions1

a. Now allow Foreign and Home to trade with each other, at zero transportation cost. Find and graph the equilibrium under free trade. What is the world price? What is the volume of trade?

b. Home imposes a specific tariff of 0.5 on wheat imports.

① Determine and graph the effects of the tariff on the following: (1) the price of wheat in each country; (2) the quantity of wheat supplied and demanded in each country; (3) the volume of trade.

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Questions1

② Determine the effect of the tariff on the welfare of each of the following groups:(1) Home import-competing producers; (2)Home consumers; (3) the Home government.

③ Show graphically and calculate the terms of trade gain, the efficiency loss, and the total effect on welfare of the tariff.

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Questions

Quantify the effects of a country’s tariff on sugar.

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Questions

Situation with import tariff Estimated situation without tariff

World price $0.10per pound $0.10per poundTariff $0.02per pound 0Domestic price $0.12per pound $0.10per poundDomestic consumption (billions of pounds per year)

20 22

Domestic production (billions of pounds per year)

8 6

Imports (billions of pounds per year)

12 16

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Questions

Calculate the following measures:

1. The domestic consumers’ gain from removing the tariff.

2. The domestic producers’ loss from removing the tariff.

3. The government tariff revenue loss.

4. The net effect on national well-being.

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Questions

The import duty is a 5% tariff on imported motorcycles. You are given the information shown in the table.

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QuestionsCurrent situation with 5% tariff

Estimated situation without tariff

World price $2000per cycle $2050per cycle

Tariff at 5％ $100per cycle 0

Domestic price $2100per cycle $2050per cycle

Number of cycles purchased domestically per year

100 ， 000 105 ， 000

Number of cycles produced domestically per year

40 ， 000 35 ， 000

Number of cycles imported per year

60 ， 000 70 ， 000

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Questions

Calculate the following:

1. The consumer gain from removing the duty.

2. The producer loss form removing the duty.

3. The government tariff revenue loss.

4. The net effect on the country’s well-being.

Why does the net effect on the country as a whole differ from the result in previous question?