1
Chapter 6 -- Tariffs
• INTERNATIONAL
ECONOMICS,
ECO 486
• Draft simplified
harmonized uniform tariff
schedule (HTS) for US:
http://www.usitc.gov/sec/I0
326w2m.htm
2
Learning Objectives
• Reprise the gains from trade
• Become familiar with tariffs
• Analyze the welfare cost of tariffs
• Determine the optimal tariff
• Explain the effective rate of protection
• Learn the imperfect substitutes model
4
Gains from Trade
• Static Gains (PPF doesn’t shift)
– Consumption gains
– Production gains
• Dynamic Gains (PPF does shift)
– Trade expands resources
– Trade may raise productivity
• Political Gains
5
Consumption & Production Gains
rF
C
TEXTILES, T (yards per year)
B
CIC2
CIC1
CIC0
A
X
0
SOYBEANS, S (bushels per year)
7
Dynamic Gains from Trade
• Trade may speed economic growth
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Commercial Policy
• Governments action that may change the
composition and volume of trade flows
– Tariffs
– Quotas
– Subsidies
– Other non-tariff barriers
• We’ll analyze the cost & benefits of these
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Tariffs
• Taxes on
– Imports
– Exports
– Subsidies
• Components -- See Table 6.1, page 153
– Ad valorem-- % of value
– Specific -- flat fee per unit
– Compound -- both
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Positive Effects of Tariffs
• Revenue Effect -- provide tax revenue
• Protective Effect -- shelter domestic
producers from foreign competition
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Tariff Terminology
• A pure-revenue tariff is one imposed on a
good not produced domestically
– A tariff on bananas imported to Iceland
• A prohibitive tariff is one that is so high that
none of the good is imported
– no revenue is collected
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Uses of Tariffs
• Developing countries may rely on tariffs to
provide tax revenue
• Developed countries impose tariffs for their
protective effect
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Tariffs as tools of int’l policy
• Most Favored Nation status, MFN
– granted as a reward, withheld as a punishment
• Generalized System of Preferences, GSP
– Most developed countries have GSP as means
of helping developing countries
• access to markets of developed countries
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Welfare Cost Analysis
• Use (National) Supply and Demand
– Partial equilibrium
– One import or export good
• Measure Changes in Consumer Surplus and
Producer Surplus
• Start with a small country
– Its trade is too small to affect terms of trade
Price ($ per bushel of
grapes)
Gains from free trade -- imports 18
10
6
3
2
0
1
4
7
10
Quantity (millions bushels of grapes per year)
Welfare of a Move to Free Trade
A Small Country’s Imports
Change in Consumer Surplus
Change in Producer Surplus
Net Welfare Change
20
Price ($ per jar of
honey)
Gains from free trade -- exports 22
10
9
6
2
0
1
4
7
10
Quantity (millions jars of honey per year)
Welfare of a Move to Free Trade
A Small Country’s Exports
Change in Consumer Surplus
Change in Producer Surplus
Net Welfare Change
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grapes)
Price ($ per bushel of
Welfare Cost of a Tariff
on Imports -- Small Country
10
5
3
2
0
1
3
5
7
10
Quantity (millions bushels of grapes per year)
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Welfare Cost of a Tariff
on Imports -- Small Country
Change in Consumer Surplus
Change in Producer Surplus
Change in Gov't Revenue
Net Welfare Change
(a.k.a. Deadweight loss)
Loss = 0.5 x tariff x change in imports
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Welfare Cost of a Tariff
Small Country
grapes)
Price ($ per bushel of
30
Domestic Supply
of grapes
10
World price + tariff $2/bu
5
c
b
3
2
d
World price of grapes
Domestic demand for grapes
0
1
3
5
7
10
Quantity (millions bushels of grapes per year)
Price ($ per jar of
honey)
Export Tariff -- Small Country
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Domestic Supply
of honey
10
9
6
2
Domestic demand for honey
0
1
4
7
10
Quantity (millions jars of honey per year)
Welfare Cost -- Export Tariff
Small Country Case
Change in Consumer
Surplus
+a
Change in Producer Surplus -a -b -c -d
Change in Gov't Revenue
Net Welfare Change in A
(a.k.a. Deadweight loss)
+c
-b
-d
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Price ($ per lb.)
Int’l Free Trade Eq.
Large Country
PA
PB
0
0
Quantity (lb. of Lobster per year)
37
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Learning Objectives
• Derive import demand & export supply
• Review the welfare cost of tariffs
• Learn elasticity of import demand & export
supply
• Determine the incidence (burden) of a tariff
A’s Supply
of Lobster
PA
Price ($ per lb.)
Price ($ per lb.)
Import Demand
PA
PFT
PB
PB
A’s demand
for Lobster
0
0
M = QD - QS
Quantity (lb. of Lobster per year)
40
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Price ($ per lb.)
Export Supply
B’s Supply
of L
PA
PB
PB
0
0
X = QS - QD
B’s demand
for L
QD
Quantity (lb. of Lobster per year)
QS
A’s Supply
of Lobster
Price ($ per lb.)
Price ($ per lb.)
44
Export Supply & Import Demand
PA
PA
PFT
PFT
Export Supply, X
PB
Import Demand, M
A’s demand
for Lobster
0
Q1
Q2
0
0
M = Q2 - Q1
Quantity (lb. of Lobster per year)
Price ($ per lb.)
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Export Supply & Import Demand
B’s Supply
of L
Export Supply, X
PA
PFT
PFT
PB
PB
Import Demand, M
0
0
0
M = Q2 - Q1
X = Q2‘ - Q1 ‘
B’s demand
for L
Q1’
Quantity (lb. of Lobster per year)
Q2’
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Optimal Tariffs
• Large countries may “export” part of their
tariff.
• Because they are important customers, they
force foreign supplier to cut price.
• The optimal tariff maximizes the net
welfare change
• Retaliation is likely to offset this gain
Equilibrium with a Tariff
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Price ($ per lb.)
Large Country
A’s Supply
of L
B’s Supply
of L
P”
PFT
PFT
P’
P’
A’s demand
for L
0
0
Q1 Q3
Q4 Q2
B’s demand
for L
Q1’ Q3’ Q4’ Q2’
Quantity (lb. of Lobster per year)
A’s Welfare Cost -- Import Tariff
Imposed by Large Country, A
Change in Consumer
Surplus
-a -b -c -d
Change in Producer Surplus +a
Change in Gov't Revenue
Net Welfare Change in A
(a.k.a. Deadweight loss)
+c
-b
+e
-d +e
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B’s Welfare Cost from A’s Tariff
Import Tariff Imposed by A
Change in Consumer
Surplus
+h
Change in Producer Surplus -h -i -e -j
Change in Gov't Revenue
Net Welfare Change in B
(a.k.a. Deadweight loss)
-i -e -j
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World Welfare Cost of A’s Tariff
Net Welfare Change in A
-b -d +e
Net Welfare Change in B
Net Welfare Change in
World
-e -i -j
-b -d
-i -j
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World Welfare Changes
• Tariff raises the price in A to PW + T
• Tariff lowers the world price to PW
• Tariff reduces the quantity world trade
from MFT to MT
• Welfare loss area, f = b+d
• Welfare loss area, g = i+j
Price ($ per lb.)
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Export Supply + Specific Tariff, T
T
Export Supply, X
T
Import Demand, M
0
MFT
Quantity (lb. of Lobster per year)
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Graphing Tariffs
• Specific tariff raises the y-intercept of the export
supply curve,
p=a+bq
p+T=a+bq+T
• Ad-valorem tariff raises the slope and y-intercept
of the export supply curve
p=a+bq
p (1 + t) = (a + b q) (1 + t) = (1 + t) a + (1 + t) b q
Price ($ per lb.)
Export Supply
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with Ad-Valorem Tariff, t
X(1+t)
Export Supply, X
PA
PW +T
PFT
PW
f
g
PB
Import Demand, M
0
MT
MFT
Quantity (lb. of Lobster per year)
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Price Elasticity of Demand, ed
ed and slope are inversely related.
Q P
Q P
Q P
ed      
Q
P
Q P
P Q
e
d
1
P
1
P

 

P
Q
Slope Q
Q
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The Price Elasticity of Supply, es
• The formula for price elasticity of supply,
es, at a point is shown below. Note that it’s
the same as the formula for ed , but lacks
the absolute value notation
Q P
1
P




es P Q Slope Q
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Import Demand Elasticity, em
• The formula for price elasticity of import demand,
em, at a point is shown below. Q is the quantity
of imports; P is the price; P is the change in
price; Q is the change quantity imported
e
m
Q P
1
P




Q
P
Slope Q
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Import Demand Elasticity, em
• The formula for price elasticity of import demand,
em, at a point is shown below
Qm is the quantity of imports; Qd is the quantity
demanded; Qs is the quantity supplied
Qd
Qs




em Q ed Q es
m
m
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Interpreting em
• em is directly related to A’s ed and es
• em is inversely related to the share of imports in
A’s consumption and production
Qd
Qs




em Q ed Q es
m
m
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Export Supply Elasticity, ex
• The formula for price elasticity of export supply,
ex, at a point is shown below. Q is the quantity of
exports; P is the price; P is the change in price;
Q is the change quantity exported
Q P
1
P




ex P Q Slope Q
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Export Supply Elasticity, ex
• The formula for price elasticity of export supply,
ex, at a point is shown below.
– Qx is the quantity of exports; Qd is the quantity
consumed; Qs is the quantity produced
Qd
Qs




ex Q ed Q es
x
x
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Interpreting ex
• ex is directly related to B’s ed and es
• ex is inversely related to the share of exports in
B’s consumption and production
Qd
Qs




ex Q ed Q es
x
x
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Export Supply + Specific Tariff, T
PA
X + TARIFF, T
PW +T
PFT
PW
T
f
A’s burden, b
Export Supply, X
g
PB
Import Demand, M
0
MT
MFT
Quantity (lb. of Lobster per year)
Compare em and ex
to determine A’s burden, b; 0b1
• When em = ex , b = _____
• When em > ex , b _______
• When em < ex , b _______
b
1
e
m

1
ex
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Differing em
PA
X + TARIFF, T
PW +T
PFT
PW
T
Export Supply, X
f
A’s burden, b
g
B’s burden, 1- b
Elastic M
PB
Inelastic M
0
MT
MFT
Quantity (lb. of Lobster per year)
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Differing ex
PA
Inelastic X + T
T
Inelastic X
PW +T
PFT
PW
PB
f
A’s burden, b
Elastic X
g
T
0
Elastic X + T
Import Demand, M
MT
MFT
Quantity (lb. of Lobster per year)
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Nominal & Effective Rates of Protection
• t = tariff
• P = price of good
• v = domestic value
added with free trade
• v’= domestic value
added with tariff
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Effective Rate of Protection
ERP, g j 
t j  aij ti
1  aij
gj = Effective Rate of Protection on final product j
tj = nominal tariff rate on final product j
ti = nominal tariff rate on imported input I
aij = share of I in the total value of J in the absence of tariffs
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Welfare Cost of Tariffs as a
Percentage of GDP
• Traditional: Square the tariff rate
– Ten percent tariff reduces GDP by 1%
• Tariffs & NTBs often exclude new goods
– GDP loss almost twice the tariff rate
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Imperfect Substitutes
• Increased trade in final products relative to raw
materials and intermediate goods
• A final-good import and competing domestic
products are often imperfect substitutes
• Tariff increases demand for the domestic good
• Increased price of domestic good increases
demand for the import
• Welfare cost is more difficult to estimate
Imperfect Substitutes
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Small Country -- Free Market
Price
Price of Import
SD
PD
SM
PM
DM
0
QM
Quantity of Imports
DD
0
QD
Quantity of Domestic Substitute
Welfare Cost of a Tariff
Imperfect Substitutes
Change in Consumer
Surplus
Change in Producer
Surplus
Change in Government
Revenue
Net Welfare Change
(a.k.a. Deadweight loss)
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