CHAPTER 6
Tariffs
CHAPTER OUTLINE
I.
II.
III.
IV.
V.

VI.
Introduction
Tariffs: Some Preliminary Details
A.
Types of Tariffs

revenue vs. protective tariffs

specific, compound, and ad valorem tariffs

free alongside (FAS), free on board (FOB), and cost, insurance, and
freight (CIF)

Table
B.
Methods of Valuing Imports
The Welfare Effects of Trade in an Individual Product
A.
Consumer and Producer Surplus: A Review — Figures 6.1 and 6.2
B.
The Effects of Free Trade – Figure 6.3
The Economic Effects of Tariffs
A.
The Effects of a Tariff for a Small Country — Figure 6.4
B.
The Effects of a Tariff for a Large Country — Figure 6.5


PASSPORT: Henry George on Free Trade


PASSPORT: The Economic Effects of Selected U.S. Import Tariffs —
Table 6.2
The Effective Rate of Protection

Table 6.3
Arguments for Tariffs
A.
Infant Government
B.
National Defense — Figure 6.6
C.
Infant Industries
D.
Senile Industry Protection
E.
Tariffs, Trade, and Jobs


PASSPORT: Petition of the French Candlemakers
TEACHING NOTES AND TIPS
I.
Introduction
Notes
The chapter starts with the idea that we are now relaxing one of our assumptions. What happens
if we introduce trade barriers?
120
Tariffs 121
Teaching Tip
Remember the discussion of trade and the distribution of income in Chapter 3. We have already
set the stage for the existence of trade barriers.
II.
Tariffs: Some Preliminary Details
Notes
This section introduces revenue vs. protective tariffs; the three types of tariffs (specific, ad
valorem, and compound); and the three methods of valuing tariffs (FAS, FOB, and CIF).
Teaching Tip
The three methods of valuing imports are also extensively used in international business and are
not just terms used by customs officials.
III.
The Welfare Effects of Trade in an Individual Product
Notes
The section starts with a quick review of consumer and producer surplus. From there, the effects
of imports and exports for an individual product without trade barriers can be shown in terms of
the changes in consumer and producer surplus.
Teaching Tip
Take a little longer to examine the effects of free trade before examining the effects of trade
barriers. We’ve shown the gains for free trade in a different form in Chapter 2 and this section
re-enforces the idea that free trade improves the welfare of society.
IV.
The Economic Effects of Tariffs
Notes
The effects of a tariff are shown in Figure 6.4 as the gains to producers and the government and
the losses to consumers and the economy as a whole. Figure 6.5 adds the terms of trade effect
for a large country.
Teaching Tip
Take a little longer to examine the effects of tariff for a small country before discussing the
effects for a large country. We’ve found that students understand large country effects better if
they first grasp the associated welfare loses of a tariff in a small country.
V.
The Effective Rate of Protection
Notes
This section shows that the nominal tariff can be deceiving. The first part shows an example of
this with DVD players. The formula to calculate the effective rate of protection is given. The
final part of the section is a description of the structure of protection in developed countries and
how this affects the effective rate of protection and the welfare of developing countries.
Teaching Tip
122 Chapter 6
Ask the students to consider why they see agricultural products from developing countries in the
grocery store but why they rarely see processed foods from these countries. Perhaps the
structure of protection in the U.S. might have something to do with that.
VI.
Arguments for Tariffs
Notes
This section discusses the common arguments used by individuals and businesses for imposing
tariffs. Along with each argument for tariffs, we also point out the fallacies embodied in each
argument.
Teaching Tip
It is important to note for the students that a policy of subsidizing the domestic industry results in
less dead weight loss that an equivalent tariff.
BRIEF ANSWERS TO PROBLEMS AND QUESTIONS FOR REVIEW
1.
A revenue tariff is imposed by government on a good that is not domestically produced.
A specific tariff is a tariff that is measured as a fixed amount of money per unit imported.
An ad valorem tariff is a tariff that is measured as a percentage of the value of the
imported good. A compound tariff is a tariff that includes a specific tariff and an ad
valorem tariff.
2.
The three different methods countries use to determine the value of imports are the free
alongside price, the free on board price, and the cost, insurance and freight price. The
FAS price, defines the price of the imported good as the foreign country’s market price
before it is loaded into the ship, train, truck, or airplane for shipment to the importing
country. The FOB price defines the imported price of the good as the foreign country’s
market price plus the cost of loading the good into the means of conveyance. The CIF
price defines the price of the imported good as the foreign country’s market price plus the
cost of loading the goods into the means of conveyance plus all intercountry
transportation costs up to the importing country’s port of entry.
3.
Consumer surplus is the difference between the price a consumer would be willing to pay
for the good and the market price. Producer surplus is the difference between the price at
which a good is sold and the minimum price that the seller would be willing to accept for
it.
4.
The economic effects of a tariff are caused by the higher price of imports as consumer
surplus declines. Consumers lose as a result of a tariff. Those that gain include the
government as it collects tariff revenue and domestic producers as part of the consumer
surplus is transferred to domestic producers. However, the net loss to society and loss of
consumer welfare is composed of area b + d. This loss to society is referred to as the
dead-weight loss of a tariff.
Tariffs 123
5.
The difference between the case of the large country and the small country is that part of
the tariff burden falls on consumers of the imported good and part falls on foreign
producers of the imported good. In this case, the total government revenue collected
from the tariff includes two components. The first component is the amount of the tariff
revenue that is shifted from domestic consumers to the government. The second
component is the amount of the tariff revenue that is shifted from foreign producers to the
government. This second component is called the terms of trade effect and represents a
redistribution of income from the foreign country to the domestic country. The terms of
this trade improves the welfare of the domestic country at the expense of the foreign
country. In the case of a large country, the welfare effects of a tariff are: 1) the loss of
consumer surplus, area b + d, and 2) the gain of welfare through the terms of trade affect,
area e.
6.
a.
b.
c.
7.
$11,000
Before the tariff, domestic value added is $7,500 and after the tariff the domestic
value added is $8,375.
The ERP is 11.67%.
To determine the actual degree of protection an industry receives, one must not only
consider the tariff on the final good but also any tariffs on imported components that the
industry uses to produce the final good. This means that we need to consider the impact
of tariffs on the value of the product produced domestically. A measure that accounts for
the importance of these items is called the effective rate of protection. The general
formula for determining the effective rate of protection is:
ERP = (Tf - aTc )/(1 - a)
Tf is the tariff rate on the imported final product; a is the percentage of imported
components used in producing the final product; and Tc is the tariff rate on the imported
components used to produce the final product. Since the effective rate of protection is
determined by the interaction of three variables, the potential outcomes are infinite, and
the effective rate of protection can even be negative. This occurs when the tariff on
imported components multiplied by the percentage of imported inputs into the production
process is larger than the tariff on the final good. The tariffs on final goods in the U.S.
tariff schedule are frequently small. However, a seemingly small nominal tariff coupled
with a large percentage of the product coming from imported inputs can yield a large
effective rate of protection. This phenomenon is so common that it is referred to as tariff
escalation. Any time the tariff escalates with the stage of processing, foreign producers
who wish to produce the final product with local inputs are being discriminated against.
8.
The most reasonable case that can be made for a country to impose tariffs is the infant
government argument. For a developing country, tariffs can be an attractive form of
government taxation. The developing country can design its tariffs so as to collect its
revenue in a way that is something like a progressive tax on corporate or individual
income. A second argument for tariffs is the national defense argument. Countries have
a legitimate need to take steps to ensure that the military forces of a country can operate
effectively if necessary. The argument in this case is that certain industries need to be
124 Chapter 6
protected from foreign competition to ensure an adequate output of the industry in the
case of a conflict. A third argument is the infant industry argument. The argument in
this case is that “new” industries in developing countries initially may need protection to
allow them to grow in the face of more established foreign competition. The temporary
protection also may allow the industry to become large enough to establish sufficient
economies of scale to effectively compete in world markets. Once the industry has
become internationally competitive, the protectionism is withdrawn to allow the industry
to become even more efficient. The fourth argument is the senile industry argument.
The argument for tariffs in this case is that older industries in developed countries that
once had a comparative advantage in world markets need protection from lower cost
imports. The final and most common argument for tariffs is the creation of jobs in the
economy. By imposing a tariff output in the protected industry increases and the amount
of employment in the industry likewise will expand. Rather simplistically, the tariff has
produced more “jobs.”
9.
A tariff is a costly means of accomplishing an increase in output of an industry as it
results in a dead-weight loss. A production subsidy can increase the output of a domestic
industry at a lower cost. The effect of a subsidy is to shift the domestic supply downward
by the amount of the subsidy and the industry would be willing to produce the larger
output. With a subsidy the consumer is still paying the world price for the good and as
such the dead-weight loss is only the production effect and does not include the
consumption effect.
10.
No, tariffs increase employment in the protected industry as opposed to the overall level
of employment in the economy. A tariff will create jobs in this particular industry but
there are fewer jobs in other industries. This is because consumers spend more to goods
from the protected industry but less on other goods. The tariff has not increased the total
number of jobs, it has just rearranged them. Protected industries have more jobs and
other industries have fewer jobs. The overall level of employment hasn’t changed. The
total number of jobs in the economy is determined by macroeconomic forces such as the
rate of economic growth in the long run and the state of fiscal and monetary policy in the
long run. Tariffs don’t change the total number of jobs, they just put jobs in places that
the market would not.
MULTIPLE-CHOICE QUESTIONS
1.
*
A revenue tariff is:
a.
a tariff on domestically produced products.
b.
a tariff levied on a product that is produced domestically that is designed to
protect domestic industries.
c.
a tariff levied on a product that is not domestically produced.
d.
a tariff based on the profits of international firms doing business within a country.
Tariffs 125
2.
*
3.
*
The purpose of a protective tariff is:
a.
to protect domestic consumers from harmful products.
b.
to protect the international laws of commerce.
c.
to protect the foreign country from anti-trust actions.
d.
to protect domestic producers from foreign competition.
Specific tariffs are collected:
a.
only on industrial products.
b.
only on pharmaceutical products.
c.
only on products that arrive by train.
d.
as a fixed amount of money per unit traded.
4.
*
A tariff levied as a certain amount per unit imported is known as:
a.
a specific tariff.
b.
a counter tariff.
c.
a forgone tariff.
d.
F.A.S.
5.
*
A per unit tax on imported goods is called:
a.
a specific tariff.
b.
a per unit tariff.
c.
an ad valorem tariff.
d.
a compound tariff.
6.
A tariff of 20% on imported goods is called:
a.
a specific tariff.
b.
a percentage tariff.
c.
an ad valorem tariff.
d.
a compound tariff.
*
7.
*
8.
*
Ad valorem tariffs are collected as:
a.
a percentage of the quantity of imports.
b.
fixed amounts of money per unit traded.
c.
a percentage of the price of the product.
d.
a percentage of the transportation costs.
_____ is the barrier to trade that best distinguishes among gradations of a good or service.
a.
Specific tariff
b.
Voluntary export restraint
c.
Ad valorem tariff
d.
Import quota
126 Chapter 6
9.
*
10.
*
11.
*
12.
*
13.
*
14.
*
Product “A” has an import value of $100. If a tariff of 10 percent of the product’s value
plus $10 per unit were imposed on “A”, the result would be a(n) ____ of _____ .
a.
ad valorem; $15
b.
combined; $15
c.
compound; $15
d.
compound; $20
A tariff of 20% plus $1 per unit on imported goods is called:
a.
a specific tariff.
b.
a complex tariff.
c.
an ad valorem tariff.
d.
a compound tariff.
When a tariff is so high that imports are zero, the tariff is said to be:
a.
effective.
b.
exclusionary.
c.
involuntary.
d.
prohibitive.
A compound tariff is a combination of:
a.
a specific tariff and a F.A.S. tariff.
b.
a specific tariff and a F.O.B. tariff.
c.
an ad valorem tariff and a F.A.S. tariff.
d.
a specific tariff and an ad valorem tariff.
A tariff of ($250/import + 15% of the C.I.F. value/import) is known as a(n) _____ tariff.
a.
nonspecific
b.
ad valorem
c.
compound
d.
specific
The Free alongside (FAS) method of valuing imports:
a.
defines the price of the imported good as the foreign market price before it
is loaded into the ship, train, or plane for shipment to the importing country.
b.
defines the imported price as the price in the foreign market including the cost of
loading it onto the ship, train, or plane for shipment to the importing country.
c.
defines the imported price as the price including all inter-country charges up to
the importing country’s port of entry.
d.
none of the above
Tariffs 127
15.
*
16.
*
17.
*
18.
*
19.
*
20.
*
The free on board (FOB) method of valuing imports:
a.
defines the price of the imported good as the foreign market price before it is
loaded into the ship, train, or plane for shipment to the importing country.
b.
defines the imported price as the price in the foreign market including the cost of
loading it onto the ship, train, or plane for shipment to the importing country.
c.
defines the imported price as the price including all inter-country charges up to
the importing country’s port of entry.
d.
none of the above
The FOB value of imports includes:
a.
the value of the product alongside the carrier.
b.
the expense of loading for shipment.
c.
all freight and insurance costs to transport the goods to the importing country.
d.
the sum of a and b.
CIF stands for:
a.
captain in front.
b.
capital is free.
c.
cost, insurance, and freight.
d.
a form of grease payment.
The cost, insurance and freight (CIF) method of valuing imports:
a.
defines the price of the imported good as the foreign market price before it is
loaded into the ship, train, or plane for shipment to the importing country.
b.
defines the imported price as the price in the foreign market including the cost of
loading it onto the ship, train, or plane for shipment to the importing country.
c.
defines the imported price as the price including all inter-country charges
up to the importing country’s port of entry.
d.
none of the above
Almost all countries in the world use which of the following definitions to assess the
value of an import?
a.
TTK
b.
JIT
c.
CIF
d.
JMK
The availability of alternative definitions of “price” such as FAS, CIF, and FOB creates
complications regarding the administration of the _____ tariff.
a.
ad valorem
b.
generic
c.
export
d.
specific
128 Chapter 6
21.
*
22.
*
23.
*
24.
*
25.
*
26.
*
27.
*
Which of the following is not a method of valuing imports for tariff purposes?
a.
Free alongside (FAS) price
b.
Free on board (FOB) price
c.
Cost, insurance and freight (CIF) price
d.
WTO price
The difference between the price consumers are willing to pay and the price that they
actually pay is known as:
a.
producer surplus.
b.
consumer surplus.
c.
price discrimination.
d.
government surplus.
The difference between the price producers are willing to accept for the product and the
price producers actually receive for the product is known as:
a.
producer surplus.
b.
consumer surplus.
c.
price discrimination.
d.
the firm’s profit.
The difference between what consumers have to pay for a particular product and what
they are willing to pay is known as:
a.
producer surplus.
b.
tariff revenue.
c.
the consumption bonus.
d.
consumers surplus.
Consumer surplus is equal to the:
a.
area under the demand curve and above the supply curve.
b.
area under the demand curve.
c.
area under the supply curve.
d.
area under the demand curve and above the equilibrium price.
The triangular area above the supply curve and below the market price is known as:
a.
consumer surplus.
b.
producer surplus.
c.
oligopoly.
d.
marginal revenue.
Consumer surplus will tend to rise if:
a.
the market price falls.
b.
the market price rises.
c.
there are absolutely no imports.
d.
there are absolutely no exports.
Tariffs 129
28.
*
A reduction in the price of a commodity due to an increase in supply will:
a.
increase consumer surplus.
b.
reduce consumer surplus.
c.
leave consumer surplus unchanged.
d.
cause the demand curve to shift to the right.
29.
The triangular area below the demand curve and above the market price is known as:
a.
producer surplus.
b.
consumer surplus.
c.
average total cost.
d.
marginal cost.
*
30.
*
Producer surplus is equal to the:
a.
area under the demand curve and above the supply curve.
b.
area above the supply curve and below the equilibrium price.
c.
area under the demand curve.
d.
area under the supply curve.
Use the graph below to answer the following questions:
P
S
P
Pt
World Price + Tariff
a
b
c
d
Pw
World Price
D
Q
31.
*
32.
*
The consumer surplus gained by moving from autarky to free trade is represented by:
a.
a + b + c + d.
b.
a + b.
c.
a + c.
d.
none of the above
The producer surplus lost by moving from autarky to free trade is represented by:
a.
a.
b.
b.
c.
c.
d.
none of the above
130 Chapter 6
33.
*
According to the graph, imports:
a.
have caused the price to fall from P to Pw.
b.
have caused consumer surplus to rise.
c.
have caused producer surplus to fall.
d.
all of the above
34.
*
The introduction of a tariff would raise the price from:
a.
Pw to Pt.
b.
Pt to P.
c.
Pw to P.
d.
none of the above
35.
Without a tariff the price of imports would be:
a.
a + b + c + d.
b.
b + d.
c.
P.
d.
Pw.
*
36.
*
37.
*
38.
*
39.
*
When a specific tariff is placed on an item, compared to free trade consumers lose:
a.
a.
b.
b.
c.
d.
d.
a + b + c + d.
The loss of consumer surplus due to the tariff is:
a.
a.
b.
b.
c.
d.
d.
a + b + c + d.
A tariff on imports would reduce consumer surplus by:
a.
a + b.
b.
b + c.
c.
a + b + c.
d.
a + b + c + d.
With the tariff, government revenue is:
a.
a.
b.
b.
c.
c.
d.
d.
Tariffs 131
40.
*
The imposition of a tariff would yield tariff revenue of:
a.
a.
b.
b.
c.
c.
d.
d.
41.
*
The increase in producer surplus attributable to the tariff is:
a.
a.
b.
b.
c.
c.
d.
d.
42.
*
The gain in producer’s surplus that occurs because of the tariff is:
a.
a.
b.
b + c.
c.
c.
d.
a + b + c + d.
43.
The losses to society because of the inefficient allocation of resources attributable to the
tariff is:
a.
a.
b.
b.
c.
c.
d.
b + c.
*
44.
*
45.
*
46.
*
The dead weight loss of the tariff is:
a.
a + d.
b.
b + d.
c.
c + d.
d.
b + c.
When a tariff is imposed on imported goods or services, the consumer surplus in the
domestic market _____ and producer surplus in the domestic market _____ .
a.
rises; falls
b.
rises; rises
c.
falls; falls
d.
falls; rises
When a tariff is imposed on imported goods and services, the _____ in consumer surplus
is _____ the ______ in producer surplus.
a.
increase; less than, increase
b.
increase; less than, decrease
c.
decrease; greater than, increase
d.
decrease; less than, increase
132 Chapter 6
47.
*
When a tariff is imposed on imports, domestic producer surplus:
a.
falls.
b.
rises.
c.
stays the same.
d.
becomes negative.
48.
*
Tariffs reallocate income from:
a.
consumers to producers.
b.
producers to consumers.
c.
government to producers.
d.
consumers to foreigners.
49.
Tariffs cause a redistribution of income from:
a.
the government to producers and consumers.
b.
consumers and the government to producers.
c.
producers and consumers to the government.
d.
consumers to producers and the government.
*
50.
*
If a small country imposes a tariff:
a.
the imported product price rises by more than the tariff.
b.
the imported product price rises by exactly the amount of the tariff.
c.
the imported product price rise by less than the amount of the tariff.
d.
the imported product price falls by the amount of the tariff.
The following figure illustrates the demand and supply curves for PCs in a small country. Use
this figure to answer the following questions:
P
S
a
P
b
Pt
Pw
World Price + Tariff
c
g
d
e
f
World Price
D
Q 1 Q2 Q3
51.
*
Q4
Q5
Q
With no trade the amount of domestically produced PCs is:
a.
Q1.
b.
Q2.
c.
Q3.
d.
Q1 to Q3.
Tariffs 133
52.
*
With no trade the country’s producer surplus is:
a.
area a.
b.
area b.
c.
areas b + c.
d.
areas b + c + g.
53.
*
With no trade the country’s consumer surplus is:
a.
area a.
b.
area a + b.
c.
area b.
d.
area a + b + c.
54.
With free trade the country imports:
a.
Q1.
b.
Q2.
c.
Q3.
d.
Q1 to Q5.
*
55.
*
56.
*
57.
*
58.
*
With free trade the country’s producers surplus is:
a.
area a.
b.
area b.
c.
area c.
d.
area g.
With a tariff imposed on PCs, the country imports:
a.
Q1.
b.
Q2.
c.
Q3.
d.
Q2 to Q4.
The loss of consumer surplus due to the tariff is:
a.
area c.
d.
area c + d.
c.
area c + d + e.
d.
area c + d + e + f.
The amount of producer surplus domestic producers gain as a result of the tariff is:
a.
area c.
b.
area c + d.
c.
area d.
d.
area c + d + e.
134 Chapter 6
59.
*
60.
*
61.
*
62.
*
63.
*
64.
*
The amount of revenue the government collects as a result of the tariff is:
a.
area c.
b.
area d.
c.
area e.
d.
area e + f.
The dead-weight loss of the tariff to the country is:
a.
area c + d + e + f.
b.
area d + e + f.
c.
area d + f.
d.
area d.
If a large country imposes a tariff:
a.
the imported product price rises by more than the tariff.
b.
the imported product price rises by exactly the amount of the tariff.
c.
the imported product price rises by less than the amount of the tariff.
d.
the imported product price falls by the amount of the tariff.
The imposition of an import tariff by a large country can cause:
a.
a decrease in imports.
b.
an increase in the country’s welfare.
c.
a decrease in the country’s welfare.
d.
all of the above
Assume that domestic calculators are made with foreign parts that cost $80 and that the
calculators retail for $90. If in a small country situation if a tariff of $1 is placed on the
foreign parts, then the effective rate of protection is:
a.
-10%.
c.
10%.
c.
50%.
d.
80%.
Assume that U.S.-assembled computers are made with $1,000 of components and sell for
$2,000 in the U.S. Now, a $200 tariff is imposed on foreign computers. The nominal
tariff is ______ and the effective rate of protection is ________ .
a.
10%; 10%
b.
5%; 20%
c.
20%; 50%
d.
10%; 20%
Tariffs 135
65.
*
66.
*
67.
*
68.
*
69.
*
Consider three goods: raw leather, leather wallets, and tanned leather. Assume that an
industrial country employs a tariff structure using these ad valorem tariff rates on import
of these commodities: 0%, 4.5%, and 7.9%. If this hypothetical industrial country uses a
tariff structure similar to most other industrial countries, these rates will be placed on
_____, _____, and ____, respectively.
a.
raw leather, leather wallets, tanned leather
b.
leather wallets, raw leather, tanned leather
c.
raw leather, tanned leather, leather wallets
d.
tanned leather, leather wallets, raw leather
A domestically produced DVD player sells for $500, including $250 of imported
components. A tariff of 20% is imposed on the imported DVD player. What is the
effective rate of protection?
a.
20%
b.
30%
c.
40%
d.
60%
A domestically produced DVD player sells for $500, including $250 of imported
components. A tariff of 20% is imposed on the imported DVD player, and a tariff of
10% is imposed on the imported components. What is the effective rate of protection?
a.
20%
b.
25%
c.
30%
d.
40%
Which of the following components is not necessary to determine the effective rate of
protection?
a.
The tariff on the imported final product
b.
The tariff on the imported components
c.
The percentage of imported components used in producing the final product
d.
The ratio of domestic to imported components used to assemble the final
product
Tariff escalation encourages:
a.
final processing of the product in the home country.
b.
final processing of the product in developing countries.
c.
final processing of the product and processing of component production in the
home country.
d.
final processing of the product and processing of component production in
developing countries.
136 Chapter 6
70.
*
71.
*
Tariff escalation results from:
a.
tariffs increasing as the percent of the value of product imported decreases.
b.
low tariffs on imported inputs and high tariffs on imported final products.
c.
tariffs increasing on fuel products whose value is higher than the products
produced domestically.
d.
high tariffs on imported inputs and low tariffs on imported final products.
Which of the following is not a common argument for tariffs?
a.
National defense
b.
Infant government
c.
Senile industry
d.
Senile government
72.
*
Which of the following is not a common argument for tariffs?
a.
Increase the number of jobs in the economy.
b.
National defense.
c.
Infant industry.
d.
Senile industry.
73.
*
A production subsidy:
a.
increases domestic output of the industry.
b.
decreases domestic output of an industry.
c.
is less efficient than an equivalent tariff.
d.
is more costly than an equivalent tariff.
TRUE FALSE QUESTIONS
1. F
A tariff is simply a tax on exported goods.
2. T
A revenue tariff is a tax on goods that are not domestically produced.
3. T
In a developing country tariffs may be easier to collect than income or sales taxes.
4. T
During the nineteenth century, tariffs were the major source of revenue of the U.S.
government.
5. T
Specific tariffs work best on products that essentially are homogeneous.
6. T
A constant 4-cent tariff on gasoline would be referred to as a specific tariff.
7. F
Ad valorem tariffs are a regressive form of taxation.
8. T
A tariff levied as a percentage of the value of the imported item is known as an ad
valorem tariff.
Tariffs 137
9. T
Ad valorem tariffs are most useful if the product category is characterized by vertical
product differentiation.
10. F A compound tariff is a theoretical possibility that never occurs in practice.
11. F A tariff made up of both an ad valorem component and a specific component is called a
pecuniary tariff.
12. F Ad valorem tariffs are a per unit tax on imported goods.
13. F Free on board means that the costs for loading the goods onto the conveyance is not
included in the valuation.
14. F The difference between the price producers are willing to sell the product for and the
price that they actually receive for the product is called consumer surplus.
15. T Domestic producers always gain from any type of tariff.
16. F The producer surplus gained from an import tariff is always equal to the consumer
surplus lost.
17. F As a result of a tariff, producer surplus will increase more than consumers surplus
declines.
18. F Consumer surplus is the rectangular area above the demand curve and below the
equilibrium price.
19. T If price falls, consumer surplus rises.
20. F If price falls, producer surplus rises.
21. F Tariffs improve the welfare of society because the gain in producer surplus is larger than
the loss of consumer surplus.
22. F When a country moves from autarky to free trade, it experiences net gains from exporting
goods and net losses from importing goods.
23. T Tariffs tend to raise the prices consumers pay.
24. F Tariffs tend to raise consumer surplus.
25. F Free trade can lead to a significant decline in consumer surplus.
26. T One effect of a tariff is that domestic firms gain additional producer surplus through
additional sales and higher prices.
138 Chapter 6
27. F Free trade is worse than protection for a small country.
28. T Free trade is better than no trade for a small country.
29. F The dead-weight loss of a tariff equals the sum of the net changes in consumer and
producer surplus.
30. T The effective rate of protection for a product can be negative.
31. T The least expensive way to encourage domestic output of a good is through a production
subsidy, not a tariff.
32. F The least expensive way to encourage domestic output of a good is through a tariff, not a
production subsidy.
33. T One of the arguments for tariffs is the infant government argument.
34. F Imposing tariffs can increase the overall level of employment for a country.
35. T Imposing a tariff can increase the level employment in the protected industry.
SHORT ANSWER ESSAY
1.
List and describe the various types of tariffs.
2.
Describe the different methods of valuing imports.
3.
Describe the concepts of consumer and producer surplus.
4.
A tariff tends to decrease consumer surplus and increase producer surplus. Show why
this is true.
5.
Show how the government benefits from the imposition of a tariff.
6.
Suppose that a bottle of beer sells for $1 and contains $.20 of imported inputs. If the
tariff on beer is 20 percent and the tariff on imported inputs is 5 percent, what is the
effective rate of protection?
7.
Explain the various arguments for tariffs.
8.
Why is a production subsidy less costly than a tariff in expanding output in a particular
industry?
9.
Explain why tariffs do not increase the overall level of employment in an economy.
Tariffs 139
BRIEF ANSWERS TO SHORT ANSWER ESSAY
1.
A specific tariff is a per unit tax on imported goods. It is expressed as a certain amount of
money per unit imported, such as 6 cents per imported liter or $4 per imported ton. An ad
valorem tariff is expressed as a percentage of the value of the imported good. A tariff that
is comprised of both a specific tariff and an ad valorem tariff is a compound tariff. An
example would be $4 per imported ton plus 3 percent of the value.
2.
One of the issues a country faces in administering and collecting tariffs is that its customs
valuation can be based on one of three different methods of valuing imports. One method
of valuing imports is the free alongside (FAS) price. This method defines the price of the
imported good as the foreign country’s market price before it is loaded into the ship,
train, truck, or airplane for shipment to the importing country. Another method of
valuing imports defines the imported price as the free on board (FOB) price. The FOB
price defines the price of the imported good as the foreign country’s market price plus the
cost of loading the good into the means of conveyance. The third method of valuing
imports is the cost, insurance, and freight (CIF) price. This method defines the price of
the imported good as the foreign country’s market price plus the cost of loading the
goods into the means of conveyance plus all inter-country transportation costs up to the
importing country’s port of entry.
3.
The difference between the price consumers are willing to pay and the price that they
actually pay is known as consumer surplus. Consumer surplus is represented graphically
by the triangular area above the equilibrium price and below the demand curve. This area
represents the difference between total amount of money consumers were willing to
spend on the good and what consumers actually spent purchasing the good. The size of
consumer surplus varies inversely with the price. The difference between the price
producers are willing to accept and the price that they receive is known as producer
surplus. Producer surplus is represented graphically by the triangular area below that
equilibrium price and above the supply curve. This area represents the difference
between total amount producers were willing to accept for the good and what producers
actually receive for selling the good. The size of producer surplus varies directly with the
price.
4.
P
S
P
Pt
World Price + Tariff
a
b
c
d
Pw
World Price
D
Q
140 Chapter 6
The tariff on any imported product decreases consumer surplus be areas a + b+ c+ d, and
increases producer surplus by area a.
5.
The tariff increases revenue for the government by area c.
6.
The Effective Rate of Protection is 23.75%.
7.
The first argument for tariff is the infant government argument. For a developing
country, tariffs can be an attractive form of government taxation. The developing
country can design its tariffs so as to collect its revenue in a way that is something like a
progressive tax on corporate or individual income. A second argument for tariffs is the
national defense argument. Countries have a legitimate need to take steps to ensure that
the military forces of a country can operate effectively if necessary. The argument in this
case is that certain industries need to be protected from foreign competition to ensure an
adequate output of the industry in the case of a conflict. A third argument is the infant
industry argument. The argument in this case is that “new” industries in developing
countries initially may need protection to allow them to grow in the face of more
established foreign competition. The temporary protection also may allow the industry to
become large enough to establish sufficient economies of scale to effectively compete in
world markets. Once the industry has become internationally competitive, the
protectionism is withdrawn to allow the industry to become even more efficient. The
fourth argument is the senile industry argument. The argument for tariffs in this case is
that older industries in developed countries that once had a comparative advantage in
world markets needs protection form lower cost imports. The final and most common
argument for tariffs is the creation of jobs in the economy. By imposing a tariff output in
the protected industry increases and the amount of employment in the industry likewise
will expand. Rather simplistically, the tariff has produced more “jobs.”
8.
A production subsidy can increase the output of a domestic industry at a lower cost than a
tariff as the effect of a subsidy is to shift the domestic supply downward by the amount of
the subsidy and the industry would be willing to produce the larger output. With a
subsidy the consumer is still paying the world price for the good and as such the deadweight loss is only the production effect and does not include the consumption effect.
9.
A tariff will create jobs in this particular industry but there are fewer jobs in other
industries. This is because consumers spend more on goods from the protected industry
but less on other goods. The tariff has not increased the total number of jobs, it has just
rearranged them. Protected industries have more jobs and other industries have fewer
jobs. The overall level of employment hasn’t changed. The total number of jobs in the
economy is determined by macroeconomic forces such as the rate of economic growth in
the long run and the state of fiscal and monetary policy in the long run. Tariffs don’t
change the total number of jobs, they just put jobs in places that the market would not.