Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Ad
Advanced
d IInternational
t
ti
lE
Economics
i
I This
In
Thi Lecture
L t
• Types of Commercial Policies
ECON 758
• Partial equilibrium analysis of tariffs: supply, demand
and trade in a single industry
Professor Yamin Ahmad
• Costs and benefits of tariffs
• Import quotas
Lecture 6: International
Trade Policies
• Voluntary export restraints
• Export subsidies
• Tariffs
• Quotas
• Other Nontariff Barriers
• Local content requirements
• Protectionism
6-2
Note: These lecture notes are incomplete without having attended lectures
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
R
Recall:
ll G
Gains
i ffrom F
Free T
Trade
d
St ti Gains
Static
G i From
F
Free
F
Trade
T d
T
((PS/PT)W
• Economic Gains — increase in standard of living and
economic growth that result from a country’s
engaging in free international trade
¾
¾
• A – autarky equilibrium
C
• With free trade:
Static Gains
Dynamic Gains
SIC2A
¾
Consumption moves to
point C
¾
P d ti moves tto X
Production
D
A
• Political Gains — increases in well-being that accrue
to a country because expanded trade and economic
interdependency may increase the likelihood of
reduced international hostility
Note: These lecture notes are incomplete without having attended lectures
SIC0A
X
S
E
6-3
Note: These lecture notes are incomplete without having attended lectures
• What are the
consumption and
production gains?
6-4
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
D
Dynamic
i G
Gains
i ffrom F
Free T
Trade
d
St ti Gains
Static
G i From
F
Free
F
Trade
T d
T
•
(PS/PT)W
Suppose at A, we open up
free trade, but restrict
production to remain at A
C
•
Is the country better off?
SIC2A
• Increases in economic well-being that accrue
to a country because trade expands the
country’s productive resources or raises
resource productivity
D
A
• Refers to the relationship between trade and
economic growth
SIC0A
X
S
E
Note: These lecture notes are incomplete without having attended lectures
6-5
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Note: These lecture notes are incomplete without having attended lectures
6-6
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Relationship
e a o s p Between
e ee Trade
ade a
and
d
Economic Growth
C
Commercial
i lP
Policy
li
• Trade
ade enhances
e a ces eco
economic
o cg
growth
o t tthrough
oug imports
po ts o
of
capital goods.
• Actions taken by government to influence the
country’s volume and composition of trade
• Trade
T d enhances
h
iinternational
t
ti
l diff
diffusion
i off ttechnology.
h l
• Types of Commercial Policy
• Trade is pro-competition
pro-competition.
¾
¾
• Trade expands
p
market size if economies of scale
exist.
¾
¾
Tariff
Quota
Subsidy
Nontariff Barriers (NTB)
• T
Trade
d can enlarge
l
th
the pooll off savings
i
necessary ffor
investment spending.
Note: These lecture notes are incomplete without having attended lectures
6-7
Note: These lecture notes are incomplete without having attended lectures
6-8
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
D fi iti
Definitions
D fi iti
Definitions
((cont.)…
t)
Quota
• A government
government-imposed
imposed limit on the value or quantity
of an import or export good
Subsidy
• A government payment to a domestic industry to
encourage exports or discourage imports
Nontariff Barriers
• A wide range of government policies other than tariffs
designed to affect the volume or composition of a
country’s
y international trade
• These NTBs include:
Tariff
• A tax imposed by government on either
imports or exports
• For
F what
h purpose?
?
¾
Revenue Effect: mechanism for raising
government revenue
¾
Protective Effect: protect domestic industries
against
g
foreign
g competition
p
Note: These lecture notes are incomplete without having attended lectures
¾
¾
6-9
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Health and safety standards
Government procurement policy
Note: These lecture notes are incomplete without having attended lectures
6-10
Professor Yamin Ahmad, Advanced International Economics – ECON 758
T
Types
off Tariffs
T iff
A l i T
Analyzing
Tariff
iff Eff
Effects
t
• Ad Valorem tariff — a tax equal to a certain
percentage of the good’s selling price.
• In order to analyze the effects of international
policies on trade, we will abstract from
general equilibrium
g
q
and focus on the market
for a specific product (partial equilibrium!)
¾
For example, 25% tariff on the value of imported cars.
• Specific tariff — a tax equal to a fixed amount of
money per unit sold.
¾
• Let’s take a partial equilibrium approach and
construct a model measuring how a tariff
affects a single market, say that of wheat.
For example, $1 per kg of cheese
• Compound tariff — a tax with both ad valorem and
specific components.
components
Note: These lecture notes are incomplete without having attended lectures
6-11
Note: These lecture notes are incomplete without having attended lectures
6-12
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
S
Supply,
l D
Demand
d and
dT
Trade
d iin a Si
Single
l IIndustry
d t
S
Supply,
l D
Demand
d and
dT
Trade
d iin a Si
Single
l IIndustry
d t
• Suppose that in the absence of trade the price
of wheat in the foreign country is lower than
that in the domestic country.
y
• An export supply curve (XS) is the difference between
the quantity that foreign producers supply minus the
quantity that foreign consumers demand, at each
price.
i
¾
With trade the foreign country will export: construct
p supply
pp y curve
an export
¾
With trade the domestic country will import:
construct an import demand curve
Note: These lecture notes are incomplete without having attended lectures
• An import demand curve (MD) is the difference
between the quantity that domestic consumers
demand minus the quantity that domestic producers
supply, at each price.
6-13
Professor Yamin Ahmad, Advanced International Economics – ECON 758
6-14
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Supply, Demand and Trade
in a Single Industry (cont.)
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Note: These lecture notes are incomplete without having attended lectures
Supply, Demand and Trade
in a Single Industry (cont.)
6-15
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6-16
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Supply, Demand and Trade
in a Single Industry (cont.)
Supply, Demand and Trade
in a Single Industry (cont.)
• In equilibrium,
equilibrium
import demand = export supply
domestic demand – domestic supply =
foreign supply – foreign demand
• In equilibrium,
world demand = world supply
Note: These lecture notes are incomplete without having attended lectures
6-17
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Note: These lecture notes are incomplete without having attended lectures
6-18
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Th Eff
The
Effects
t off a T
Tariff
iff
Th Effects
The
Eff t off a Tariff
T iff (cont.)
(
t)
• A tariff acts as an added cost of transportation,
making shippers unwilling to ship goods unless the
price difference between the domestic and foreign
markets exceeds the tariff.
• Thus
Thus, a tariff will make the price of a good rise
in the domestic market and will make the
price of a good fall in the foreign market, until
the
h price
i diff
difference equals
l the
h tariff.
iff
• If shippers are unwilling to ship wheat
wheat, there is excess
demand for wheat in the domestic market and excess
supply in the foreign market.
¾
The price of wheat will tend to rise in the domestic market.
¾
The price of wheat will tend to fall in the foreign market.
Note: These lecture notes are incomplete without having attended lectures
6-19
¾
P T – P *T = t
¾
P T = P*T + t
¾
The price of the good in foreign (world) markets
should
h ld ffallll if th
there iis a significant
i ifi
t drop
d
iin th
the
quantity demanded of the good caused by the
domestic tariff.
Note: These lecture notes are incomplete without having attended lectures
6-20
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Th Effects
The
Eff t off a Tariff
T iff (cont.)
(
t)
Th Effects
The
Eff t off a Tariff
T iff (cont.)
(
t)
• Because the price in domestic markets rises (to PT),
)
domestic producers should supply more and
domestic consumers should demand less.
¾
The quantity of imports falls from QW to QT
• Because the price in foreign markets falls (to P*T),
foreign producers should supply less and foreign
consumers should demand more
more.
¾
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6-21
Professor Yamin Ahmad, Advanced International Economics – ECON 758
The quantity of exports falls from QW to QT
Note: These lecture notes are incomplete without having attended lectures
6-22
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Th Effects
The
Eff t off a Tariff
T iff (cont.)
(
t)
Th Effects
The
Eff t off a Tariff
T iff in
i a Small
S ll Country
C
t
• The quantity of domestic import demand equals the
quantity of foreign export supply when PT – P*T = t
• When a country is “small”
small , it has no effect on the
foreign (world) price of a good, because its demand
for the good is an insignificant part of world demand.
• In this case, the increase in the price of the good in
the domestic country is less than the amount of the
tariff.
tariff
¾
Part of the tariff is reflected in a decline of the foreign
country’s export price, and thus is not passed on to domestic
consumers.
consumers
¾
But this effect is often not very significant.
Note: These lecture notes are incomplete without having attended lectures
6-23
¾
Therefore, the foreign price will not fall, but will remain at Pw
¾
The price in the domestic market, however, will rise to PT =
Pw + t
Note: These lecture notes are incomplete without having attended lectures
6-24
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
The Effects
of a Tariff in a Small Country (cont.)
Eff ti Rate
Effective
R t off Protection
P t ti
• The amount of p
protection p
provided to the
domestic content of a product by the tariff
structure of a country.
• Nominal rate of protection — equals the tariff
on the final good divided by the free-trade
price of the p
p
product.
¾
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6-25
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Note: These lecture notes are incomplete without having attended lectures
6-26
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Eff ti R
Effective
Rate
t off P
Protection
t ti
E
Example
l 1
1: Eff
Effective
ti R
Rate
t off Protection
P t ti
• For example, suppose that an automobile sells on the
world market for $8000, and the parts that made it are
worth $6000.
• Effective rate of protection - measures how much
protection a tariff or other trade policy provides
domestic producers.
¾
¾
Effective Rate of Protection (ERP) = (v’-v)/v
¾
It represents the change in value that an industry adds to the
production p
p
process when trade p
policy
y changes.
g
¾
The change in value that an industry provides depends on
the change in prices when trade policies change.
¾
Effective rates of protection often differ from tariff rates
because tariffs affect sectors other than the protected sector,
a fact which affects the prices and value added for the
protected sector.
Note: These lecture notes are incomplete without having attended lectures
Nominal Rate of Protection (NRP) = t/P
6-27
The value added of the auto production is
$8000-$6000
• Suppose that a country puts a 25% tariff on imported
autos so that domestic auto assembly firms can now
charge
g up
p to $
$10000 instead of $
$8000.
• Now auto assemblyy will occur if the value added is up
p
to $10000-$6000.
Note: These lecture notes are incomplete without having attended lectures
6-28
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
E
Example
l 1
1: Eff
Effective
ti R
Rate
t off Protection
P t ti (cont.)
(
t)
E
Example
l 2
2:
• Nominal rate of Protection = $2000/$8000 = 25%
• Assume that it takes 5 yards of textiles to produce a
suit.
suit
¾
¾
• Th
The effective
ff ti rate
t off protection
t ti for
f domestic
d
ti auto
t
assembly firms is the change in value added:
($4000 - $2000)/$2000 = 100%
• Under free trade, the price of the suit would be:
5x$20 + $50 = $150
• In this case, the effective rate of protection is greater
than the tariff rate.
• Suppose that the government imposes a tariff of 20%
on imported suits.
¾
Note: These lecture notes are incomplete without having attended lectures
Let the domestic value added, i.e. amount paid to domestic
factors (e.g. rent, wages etc) equal $50 per suit.
Suppose textiles are available from domestic and foreign
suppliers at $20 per yard.
6-29
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Price of suits go up by: 0.2x$150 = $30
Note: These lecture notes are incomplete without having attended lectures
Professor Yamin Ahmad, Advanced International Economics – ECON 758
E
Example
l 2 ((cont.)…
t)
Q
Question…
ti
• Since textiles are available at $20 per yard on the
world market, so still costs $100 (for 5 yards per suit)
• Suppose that government introduces a second tariff
on textiles, equal to 10%
• Thus $80 from suits go to domestic primary factors
(i.e. higher wages, rent, profits).
• What is the increase in the price of textiles and the
cost of textiles in making a suit?
• Increase in domestic value added = $30, thus:
• Can the producer pass these costs to the public?
¾
NRP = $30/$150 = 20%
¾
ERP = ($80 - $50)/$50 = 60%
Note: These lecture notes are incomplete without having attended lectures
6-30
• Calculate the ERP in this scenario.
6-31
Note: These lecture notes are incomplete without having attended lectures
6-32
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Ill t ti off Effective
Illustration
Eff ti Rates
R t off Protection
P t ti
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6-33
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Note: These lecture notes are incomplete without having attended lectures
Professor Yamin Ahmad, Advanced International Economics – ECON 758
T l ffor Analyzing
Tools
A l i T
Tariff
iff Effects
Eff t
C
Consumer
S
Surplus
l
• A tariff raises the price of a good in the importing
country so we expect it to hurt consumers and
country,
benefit producers there.
• In addition, the government gains tariff revenue from
a tariff.
• Consumer surplus measures the amount
that a consumer gains from a purchase by the
difference in the p
price he p
pays
y from the p
price
he would have been willing to pay.
¾
The price he would have been willing to pay
is determined by a demand (willingness to
buy) curve.
¾
When the price increases, the quantity demanded
decreases as well as the consumer surplus.
• How to measure these costs and benefits?
• To that end, it is useful to review two concepts:
¾
¾
Consumer Surplus
Producer Surplus
Note: These lecture notes are incomplete without having attended lectures
6-34
6-35
Note: These lecture notes are incomplete without having attended lectures
6-36
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
C
Consumer
S
Surplus
l ((cont.)…
t)
P d
Producer
S
Surplus
l
• If monopolist
produced
good G:
P
¾
P1
P2
¾
P’
A
P
The highest
bidder pays
P1 for first unit
Next highest
pays P2 for
next unit…
• Producer surplus measures the amount that a
producer gains from a sale by the difference in the
price he receives from the price he would have been
willing
illi tto sellll at.
t
¾
The price he would have been willing to sell at is determined
pp y ((willingness
g
to sell)) curve.
byy a supply
¾
When price increases, the quantity supplied increases as
well as the producer surplus.
• Suppose P is
market price
¾
DG
O
1
Q
2
QG
Note: These lecture notes are incomplete without having attended lectures
Consumer
Surplus given
by yellow
triangle
6-37
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Note: These lecture notes are incomplete without having attended lectures
P
SG
• Supply curve
tells us the
minimum
amount that
producers
accept to
place a given
quantity of G
on the market.
Ga s from
Gains
o Free
ee Trade
ade for
o aS
Small
a
Country
• Returning
g back to the discussion about the static
benefits of trade…
• Within a partial equilibrium setup, we can look at the
gains from trade in terms of
¾
Imports Side
¾
Exports Side
• Assume that country A is a small country:
P0
¾
O
6-38
Professor Yamin Ahmad, Advanced International Economics – ECON 758
P d
Producer
S
Surplus
l ((cont.)…
t)
P
• It represents the short run profits (plus total fixed
costs of production)
1
Q
Note: These lecture notes are incomplete without having attended lectures
QG
6-39
Once international trade begins, consumers in A can buy as
much G as they want on the world markets without affecting
the world price (i.e. is price taker on the world market)
Note: These lecture notes are incomplete without having attended lectures
6-40
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Th G
The
Gains
i F
From T
Trade
d (I
(Importt Side)
Sid )
Eff t off Free
Effects
F
Trade
T d on the
th Imports
I
t Side
Sid
• Consumption effect
• Autarky
equilibrium
ilib i
att
(PA,QA)
¾
• After free trade
trade,
price of grapes (G)
falls to PW<PA
•
Consumers are better off (lower price to purchase
product)
• Production effect
¾
Difference
between domestic
consumption and
domestic
production of G is
imports
Producers are worse off (lower price leads to
reduction in quantity supplied)
• How do we determine whether we are better
off overall?
¾
6-41
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Professor Yamin Ahmad, Advanced International Economics – ECON 758
Examine changes in consumer/producer surplus
Note: These lecture notes are incomplete without having attended lectures
Professor Yamin Ahmad, Advanced International Economics – ECON 758
T d Eff
Trade
Effects
t on Imports
I
t Side
Sid (cont.)
(
t)
G i ffrom T
Gains
Trade
d (E
(Exportt Sid
Side))
Net welfare effect
• Autarky price of
honey (H) given
by P’A
Change in Consumer Surplus
+$a
Change in Producer Surplus
-$a
NET WELFARE CHANGE
Note: These lecture notes are incomplete without having attended lectures
6-42
+$b
$b
• Suppose world
price of honey,
P’W> P’A
+$c
• After free trade,
difference
between domestic
production and
consumption is
exports
t
$c
6-43
Note: These lecture notes are incomplete without having attended lectures
6-44
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Eff t off Free
Effects
F
Trade
T d on the
th Exports
E
t Side
Sid
T d Eff
Trade
Effects
t on Exports
E
t Side
Sid (cont.)
(
t)
• Consumption effect
¾
Net welfare effect
Consumers are worse off (higher price to purchase
product)
• Production effect
¾
Change in Consumer Surplus
-$e
-$f
Change in Producer Surplus
$e
+$f
Producers are better off (higher price leads to
reduction in quantity supplied)
• Welfare Gains:
¾
NET WELFARE CHANGE
Determined from overall change
g in consumer and
producer surpluses…
Note: These lecture notes are incomplete without having attended lectures
6-45
Professor Yamin Ahmad, Advanced International Economics – ECON 758
$g
Note: These lecture notes are incomplete without having attended lectures
6-46
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Effects of a Tariff Imposed by a Small Country
Effects of a Tariff Imposed by a Small Country
• Suppose that the
gov’tt of A (a small
gov
country) imposes a
tariff on imports of
grapes off t dollars.
•
Under free trade,
country A imported Q2 –
Q1 quantity of grapes.
•
Post tariff, price of
foreign grapes higher
than domestic grapes,
¾
• Si
Since A iis a smallll
country, it cannot
affect the world
price for grapes,
so consumers pay
for the entire tariff
Note: These lecture notes are incomplete without having attended lectures
+$g
•
6-47
Hence, domestic
producers raise their
own price and new
producers on the
margin
i enter
t th
the
industry
Production increases
from Q1 to Q3
Note: These lecture notes are incomplete without having attended lectures
6-48
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Effects of a Tariff Imposed by a Small Country
Eff t off a Tariff
Effects
T iff Imposed
I
d by
b a Small
S ll Country
C
t
• Total grape
p
falls!
consumption
¾
Net welfare effect
Q2 to Q4
Change in Consumer
Surplus
-$a
Change in Producer
p
Surplus
$a
-$b
-$c
-$d
• Substitution
S b tit ti effect:
ff t
¾
Higher price for
product leads some
consumers to
t
substitute towards
other products.
Change in
government Revenue
$c
• Income effect:
¾
NET WELFARE
CHANGE
People
p cannot afford
to buy as many
grapes
Note: These lecture notes are incomplete without having attended lectures
6-49
Professor Yamin Ahmad, Advanced International Economics – ECON 758
¾
Producer surplus increase (making its producers
better off).
6-50
Welfare Cost of Tariff Imposed by a Small
Country
• A tariff raises the price of a good in the
importing country, making its:
Consumer surplus decrease (making its
consumers worse off) and
-$d
$
Professor Yamin Ahmad, Advanced International Economics – ECON 758
C t and
Costs
dB
Benefits
fit off Tariffs
T iff
¾
Note: These lecture notes are incomplete without having attended lectures
-$b
$b
• Definition: Deadweight Loss/Cost —value of
wasted resources devoted to expanded
domestic production and expenditures
devoted
de
oted to less-desired
ess des ed subst
substitutes
tutes b
brought
oug t
about by a tariff
• Government revenue will increase.
Note: These lecture notes are incomplete without having attended lectures
6-51
Note: These lecture notes are incomplete without having attended lectures
6-52
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Two Deadweight Costs of the Tariff
•
Production deadweight cost —
refers to the protective effect of
th ttariff
the
iff which
hi h allows
ll
d
domestic
ti
firms to increase production
above free trade levels (area b).
•
Consumer deadweight cost —
the value of lost consumer
satisfaction due to a shift in
consumption to less-desired
substitutes brought on by the
higher price (area d).
•
F
Free
Trade
T d with
ith a Large
L
C
Country
t
• Assume country A is a large country (with market
power) importing from country B
PW
PW
Total deadweight cost = ½ x
tariff x reduction in imports
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6-53
Professor Yamin Ahmad, Advanced International Economics – ECON 758
6-54
Note: These lecture notes are incomplete without having attended lectures
Professor Yamin Ahmad, Advanced International Economics – ECON 758
• Equilibrium world price — the price (PW) at which the
quantity that consumers in A want to import is equal to
the quantityy producers in B want to export.
Illustration of a Tariff for a Large Country
• Because of its market power, the large country is
able to shift p
part of the burden of the tariff onto the
exporting country.
PT
PW
t
PW
Note: These lecture notes are incomplete without having attended lectures
6-55
PW
PW
PT*
PT*
Note: These lecture notes are incomplete without having attended lectures
6-56
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Welfare
e a e Effects
ec s o
of a Tariff
a o
on a Large
a ge
Country
C t and
Costs
dB
Benefits
fit off Tariffs
T iff (cont.)
(
t)
• For a “large” country that can affect foreign (world)
prices the welfare effect of a tariff is ambiguous.
prices,
ambiguous
• The greater the tariff burden or revenue paid
by foreign exporters compared to the large
country’s deadweight costs, the greater the
welfare increase in the large country
• The triangles b and d represent the
efficiency/deadweight loss.
¾
The tariff distorts production and consumption decisions:
producers produce too much and consumers consume too
little compared to the market outcome.
• The rectangle e represents the terms of trade gain.
¾
The terms of trade increases because the tariff lowers
foreign export (domestic import) prices.
6-57
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Professor Yamin Ahmad, Advanced International Economics – ECON 758
-$a
Change in
Producer
S l
Surplus
$a
-$b
NET
WELFARE
CHANGE
-$c
C t and
Costs
dB
Benefits
fit off Tariffs
T iff (cont.)
(
t)
• Government revenue from the tariff equals the tariff
rate times the quantity of imports.
-$d
¾
¾
¾
Change in
government
Revenue
+$e
+$c
Note: These lecture notes are incomplete without having attended lectures
-$d
$d
+$e
$e
6-59
t = PT – P*T
QT = D2 – S2
Government revenue = t x QT = c + e
• Part of government revenue (rectangle e) represents
the terms of trade gain, and part (rectangle c)
represents part of the value of lost consumer surplus
surplus.
¾
-$b
$b
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Professor Yamin Ahmad, Advanced International Economics – ECON 758
Welfare Cost of a Tariff Imposed By A Large
Country
Net welfare effect
Change in
Consumer
Surplus
Note: These lecture notes are incomplete without having attended lectures
The government gains at the expense of consumers and
foreigners.
Note: These lecture notes are incomplete without having attended lectures
6-60
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
C t and
Costs
dB
Benefits
fit off Tariffs
T iff (cont.)
(
t)
T iff Terms
Tariff
T
• If the terms of trade gain exceeds the efficiency loss
loss,
then national welfare will increase under a tariff, at the
expense of foreign countries.
• Optimal Tariff: The size of a tariff that raises
the welfare of a tariff-imposing country by the
greatest amount relative to free-trade welfare
levels.
levels
¾
However, this analysis assumes that the terms of trade does
not change due to tariff changes by foreign countries (i.e.,
due to retaliation).
• Trade (or Tariff) War: A general reduction in
world trade brought about by retaliation and
increases in trade barriers around the world
Note: These lecture notes are incomplete without having attended lectures
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Professor Yamin Ahmad, Advanced International Economics – ECON 758
Note: These lecture notes are incomplete without having attended lectures
6-62
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Q t
Quota
T
Types
off Quotas
Q t
• A government imposed limit on the quantity or
value of a good traded between countries
• Embargo — complete ban on import of a certain
good.
• Example: U.S. imposed an import quota of no
more than
th 1
1.25
25 million
illi ttons off sugar ffrom
1993 to 1994
• Tariff Rate Quota (TRQ) — allows a certain quantity
of a good into a country at low or zero tariff rate, but
applies higher tariff to quantities exceeding the quota.
• Voluntary Export Restraint (VER) — an indirect quota
resulting from an exporting country “voluntarily”
limiting its exports
exports.
Note: These lecture notes are incomplete without having attended lectures
6-63
Note: These lecture notes are incomplete without having attended lectures
6-64
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Welfare Effects of a Quota in a Small
Country
Q t License
Quota
Li
• Consider the
market for
motorbikes where
the world price of
bikes is assumed
to be $1000.
• A license which gives the bearer the right to
import into a country a specific amount of a
good during
g
g a specific
p
time p
period
• Licenses
Li
may b
be sold
ld or given
i
away.
• Under free trade:
• The recipients of the licenses may be
domestic or foreign.
Note: These lecture notes are incomplete without having attended lectures
6-65
Professor Yamin Ahmad, Advanced International Economics – ECON 758
¾
Local producers
increase output
¾
Production = 10000
¾
Imports = 40000
Note: These lecture notes are incomplete without having attended lectures
6-66
Welfare Effects of a Quota in a Small
Country
• Change in
consumer surplus:
• Suppose gov’t
imposes a quota
that limits imports
to 20000
Prices rise
Consumption =
50000
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Welfare Effects of a Quota in a Small
Country
¾
¾
¾
-$(a+b+c+d)
• Change in
producer surplus
(to domestic firms):
¾
+$a
• New equilibrium at:
¾
Price = $1500
$
¾
Consumption =
44000
¾
Production = 24000
¾
Imports = 20000
Note: These lecture notes are incomplete without having attended lectures
• Deadweight loss:
-$(b+d)
• What about area
c?...
6-67
Note: These lecture notes are incomplete without having attended lectures
6-68
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Q t R
Quota
Rentt
Wh Gets
Who
G t the
th Quota
Q t Rent?
R t?
• Area c is the Quota Rent
• Government
• Quota Rent: Profit that accrues to whoever
has the right to bring imports into the country
and sell these goods in the protected market
• Domestic
D
i producers
d
or iimporters
• Foreign producers
• It equals the change in price that results from
the imposition of the quota, multiplied by the
amount of the quota restriction (i
(i.e.
e imports)
imports).
Note: These lecture notes are incomplete without having attended lectures
6-69
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
G
Government
t Auctions
A ti
Licenses
Li
• When the government sells or auctions quota
licenses, the welfare effects are identical to
those of a tariff which raises the product price
b the
by
h same amount ((refer
f to T
Table
bl 7.1).
1)
• Studies estimate that the U.S. government
loses between $3.7 billion to $6.8 billion
yearly by not holding auctions
auctions.
Welfare Effects of a Quota: Government
Auctions Licenses
Table 7.1:
Change in Consumer
Surplus
-$a
Change in Producer
Surplus
p
$a
-$b
Change in
government Revenue
NET WELFARE
COST
Note: These lecture notes are incomplete without having attended lectures
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Note: These lecture notes are incomplete without having attended lectures
6-71
Note: These lecture notes are incomplete without having attended lectures
-$c
-$d
+$c
-$b
$b
-$d
$
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Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
D
Domestic
ti Fi
Firms G
Gett Licenses
Li
V l t
Voluntary
E
Exportt Restraint
R t i t
• When government gives the quota licenses to
domestic producers or importers, the latter
group
g
p effectively
yg
gets the q
quota rent.
• A voluntary export restraint works like an import
quota, except that the quota is imposed by the
exporting country rather than the importing country.
• However, these restraints are usually requested by
the importing country
country.
• P
Profits
fit to
t domestic
d
ti firms
fi
rise
i b
by $(
$(a+c)) while
hil
government revenue is unchanged.
• The profits or rents from this policy are earned by
foreign governments or foreign producers.
¾
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Note: These lecture notes are incomplete without having attended lectures
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Table 7.2:
-$a
$a
Change in Producer
Surplus
$a
-$b
$b
1
-$c
Equivalence
qu a e ce o
or Nonequivalence
o equ a e ce o
of Tariffs
a s
and Quotas
• They are similar in their effects on prices
prices,
output, and imports.
-$d
$d
0
-$b
-$c
• With tariff,
tariff the domestic monopolist can only
charge the world price plus tariff; with quota,
the monopolist can charge higher price and
produce less.
-$d
-$(b+d)
$(b+d) are the deadweight loss of the VER; -$
$ represents the income transfer
to foreigners
Note: These lecture notes are incomplete without having attended lectures
6-74
• Tariff revenue goes to government, while
quota rent
e t depe
depends
ds o
on who
o gets tthe
e license.
ce se
Change in
government Revenue
NET WELFARE
COST1
Note: These lecture notes are incomplete without having attended lectures
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Welfare Effects of a Voluntary Export Restraint
Change in Consumer
Surplus
Foreigners sell a restricted quantity at an increased price.
6-75
Note: These lecture notes are incomplete without having attended lectures
6-76
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Equivalence
qu a e ce o
or Nonequivalence
o equ a e ce o
of Tariffs
a s
and Quotas (cont.)
• With a tariff,
tariff an increase in demand will be
met by a rise in imports; with a quota, no new
imports are allowed in.
E
Export
t Subsidy
S b id
• An export subsidy can also be specific or ad valorem
¾
A specific subsidy is a payment per unit exported.
¾
An ad valorem subsidy is a payment as a proportion of the
value exported.
• An export subsidy raises the price of a good in the
p
g country,
y making
g its:
exporting
• Quotas are
a e more
o e difficult
d cu t to ad
administer
ste
because of the problem of how to give away
licenses and the likelihood of graft and
corruption.
corruption
¾
Consumer surplus decrease (making its consumers worse
off)
¾
Producer surplus increase (making its producers better off).
• Government revenue will decrease.
Note: These lecture notes are incomplete without having attended lectures
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Professor Yamin Ahmad, Advanced International Economics – ECON 758
Note: These lecture notes are incomplete without having attended lectures
6-78
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Export
Subsidy
(cont )
(cont.)
E
Export
t Subsidy
S b id ((cont.)
t)
• An export subsidy raises the price of a good in the
exporting country, while lowering it in foreign
countries.
• In contrast to a tariff, an export subsidy worsens the
terms of trade by lowering the price of domestic
products in world markets.
Note: These lecture notes are incomplete without having attended lectures
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Note: These lecture notes are incomplete without having attended lectures
6-80
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
E
Export
t Subsidy
S b id ((cont.)
t)
E
Export
t Subsidy
S b id ((cont.)
t)
•
An export subsidy unambiguously produces a negative effect on
national welfare.
• A direct or indirect payment by a country’s
government to one or more of its export industries.
•
The triangles b and d represent the efficiency/deadweight
loss.
¾
• Forms
F
off exportt subsidies
b idi iinclude:
l d
¾
The tariff distorts production and consumption decisions: producers
produce too much and consumers consume too little compared to
the market outcome.
¾
¾
¾
¾
•
The area b + c + d + e + f + g represents the cost of
government subsidy.
¾
¾
In addition, the terms of trade decreases, because the price of
exports falls in foreign markets to P*s.
Note: These lecture notes are incomplete without having attended lectures
6-81
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Domestic producers gain.
•
Taxpayers pay for the
subsidy.
•
Cost to society is a
production deadweight
cost.
•
With the subsidy and free
trade goods sell at the
trade,
world price, so there is no
consumption deadweight
cost (as compared to a
tariff).
Note: These lecture notes are incomplete without having attended lectures
6-82
L
Local
lC
Content
t tR
Requirement
i
t
Shifts the domestic supply
down byy the amount of the
subsidy.
•
Note: These lecture notes are incomplete without having attended lectures
Professor Yamin Ahmad, Advanced International Economics – ECON 758
D
Domestic
ti P
Production
d ti S
Subsidy
b id
•
Tax rebates
Subsidized loans to foreign
g p
purchasers
Insurance guarantees
Funding for research & development
Guarantees against losses
Direct grants
• A local content requirement is a regulation that
requires a specified fraction of a final good to be
produced domestically.
• It may
y be specified
p
in value terms, by
y requiring
q
g that
some minimum share of the value of a good
represent domestic valued added, or in physical units.
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Note: These lecture notes are incomplete without having attended lectures
6-84
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
L
Local
lC
Content
t tR
Requirement
i
t ((cont.)
t)
L
Local
lC
Content
t tR
Requirement
i
t ((cont.)
t)
• From the viewpoint of domestic producers of inputs
inputs, a
local content requirement provides protection in the
same way that an import quota would.
• Local content requirement provides neither
government revenue (as a tariff would) nor quota
rents.
• From the viewpoint
p
of firms that must buy
y domestic
inputs, however, the requirement does not place a
strict limit on imports, but allows firms to import more
if they also use more domestic parts
parts.
• Instead the difference between the p
prices of domestic
goods and imports is averaged into the price of the
final good and is passed on to consumers.
Note: These lecture notes are incomplete without having attended lectures
6-85
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Oth T
Other
Trade
d P
Policies
li i
S
Summary
off Effects
Eff t
• Countervailing Duty
¾
A tariff imposed by an importing country designed to offset
an export subsidy and resulting low prices charged by
exporters.
• Government procurement
¾
Government agencies are obligated to purchase from
d
domestic
ti suppliers,
li
even when
h th
they charge
h
hi
higher
h prices
i
(or have inferior quality) compared to foreign suppliers.
• Bureaucratic regulations
g
¾
Safety, health, quality or customs regulations can act as
a form of protection and trade restriction.
Note: These lecture notes are incomplete without having attended lectures
6-86
Note: These lecture notes are incomplete without having attended lectures
Tariff
Export
p
subsidy
Import
p q
quota
Voluntaryy
export
restraint
Producer
surplus
Increases
Increases
Increases
Increases
Consumer
surplus
l
Decreases
Decreases
Decreases
Decreases
Government
net revenue
I
Increases
D
Decreases
Ambiguous,
falls for small
country
Decreases
National
welfare
6-87
Note: These lecture notes are incomplete without having attended lectures
No change:
No change:
rents to
rents to
license holders foreigners
Ambiguous,
Decreases
falls for small
country
6-88
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
A
Arguments
t for
f Protection
P t ti
I
Invalid
lid A
Arguments
t
• Patriotism
• Protectionism is harmful to national welfare
under many circumstances.
• Employment
• So,
So why do governments impose protection?
¾
Are there circumstances where protection is a
valid means to a policy goal?
¾
One of the most cited arguments is that it
creates/preserves jobs
¾
It assumes that since output expands in the
protected sector,
sector employment across the country
might rise:- ignores general equilibrium effects!
• Invalid arguments
¾
Justifications for p
protection that have little logical
g
merit
• Fallacy of composition
¾
• vs. Valid arguments
Note: These lecture notes are incomplete without having attended lectures
6-89
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Note: These lecture notes are incomplete without having attended lectures
6-90
Professor Yamin Ahmad, Advanced International Economics – ECON 758
I
Invalid
lid A
Arguments
t
V lid A
Valid
Arguments
t
• Fair p
play
y for domestic industry
y
¾
Since it is good for the protected industry, must be
good for all industries!
• Government revenue
Domestic industry wants “even playing field” on
which to compete
• Income redistribution (- changes in surpluses)
• Non-economic
N
i goals
l ((national
i
ld
defense)
f
)
• Infant industry
• Preservation of the home market
• Domestic distortions (e.g. price supports)
p
• Environmental protection
• Strategic trade policies
Note: These lecture notes are incomplete without having attended lectures
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Note: These lecture notes are incomplete without having attended lectures
6-92
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Problems
ob e s with
National Defense Argument
I f t Industry
Infant
I d t Argument
A
t
• Argument that new industries may need temporary
protection until they have mastered the production
and marketing techniques necessary to be
competitive
p
in the world market
• This argument is over
over-used.
used
• Defense needs may be better served by
allowing or expanding imports rather than
restricting them.
• The argument presumes that the protected industry
will grow up and mature.
• A better
b tt policy
li ffor meeting
ti defense
d f
needs
d iis
through a domestic production subsidy with
free trade
trade.
• It assumes that the government is capable of picking
winners better than the private sector is.
Note: These lecture notes are incomplete without having attended lectures
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Professor Yamin Ahmad, Advanced International Economics – ECON 758
Note: These lecture notes are incomplete without having attended lectures
Professor Yamin Ahmad, Advanced International Economics – ECON 758
Summary
S
Summary
(cont.)
(
t)
1. A tariff decreases the world price of the imported
good when a country is “large”
large , increases the
domestic price of the imported good and reduces
the quantity traded.
4. The welfare effect of a tariff, quota and export
subsidy can be measured by:
2. A quota does the same.
3. An export subsidy decreases the world price of the
exported good when a country is “large”
large , increases
the domestic price of the exported good and
increases the quantity produced.
Note: These lecture notes are incomplete without having attended lectures
6-94
6-95
¾
Efficiency loss from consumers and producers
¾
Terms of trade gain or loss
5 With import quotas
5.
quotas, voluntary export restraints and
local content requirements, the government of the
importing country receives no revenue.
6. With voluntary export restraints and occasionally
import quotas, quota rents go to foreigners.
Note: These lecture notes are incomplete without having attended lectures
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Professor Yamin Ahmad, Advanced International Economics – ECON 758
Note: These lecture notes are incomplete without having attended lectures
6-97