The Instruments of Trade Policy
• The Analysis of Tariffs
– First lets build our graphical model
•
•
•
•
Home import demand
Foreign exports supply
World Equilibrium with free trade
Then impose the tariff
– Big player
– Small player
• Home import demand curve
– Maximum quantity of imports the Home
country would like to consume at each price of
the imported good.
Md = Qd(P) – Qs(P)
• Foreign export supply curve
– Maximum quantity of exports Foreign would
like to provide the rest of the world at each
price.
Xs = Qs*(P*) – Qd*(P*)
• Important things to keep in mind about the Md curve:
- Intercept on the vertical axis represents the no-trade price
- Flatter than the domestic demand curve in the importing country
S
Price, P
Price, P
A
PA
2
P2
1
P1
MD
D
S1 S2
D2 D1 Quantity, Q
D2 – S2
D1 – S1
Quantity, Q
1
• Important things to keep in mind about the Xs curve:
- Intercept on the vertical axis represents the no-trade price
- Flatter than the domestic supply curve in the exporting country
Price, P
Price, P
S*
XS
P2
P1
P*A
D*
D*2 D*1
S*1 S*2 Quantity, Q
S*1 – D*1 S*2 – D*2 Quantity, Q
Price, P
XS
1
PW
MD
QW
Quantity, Q
• Effects of a Tariff
– First lets look at the two large countries case.
– Home imposes a tax of $2 on every bushel of
wheat imported.
• Unless the price difference between the two markets
is at least $2, the shippers wont be willing to move
wheat from Foreign to Home.
2
Home market
market
Home
Price, P
PT
PW
World
World market
market
Foreign
market
Foreign
market
Price, P
S
Price, P
S*
XS
2
t
P*T
1
3
MD
D*
D
Quantity, Q
QT QW
Quantity, Q
Quantity, Q
• With the tariff in place, the price of wheat rises to
PT at Home and falls to P*T at Foreign until the
price difference is $t.
P*T= PT – t
• Home producers supply more and consumers
demand less: fewer imports are demanded.
• Foreign producers supply less and consumers
demand more: fewer exports are supplied.
• The volume of trade declines due to the tariff.
• The difference between a Big and a Small
Country:
• In the case where Home is a big country:
– The increase in the domestic Home price is less than
the tariff, because part of the tariff is reflected in a
decline in Foreign’ s export price.
• If Home is a small country:
– The foreign export prices are unaffected and the
domestic price at Home (the importing country) rises
by the full amount of the tariff.
3
The Instruments of Trade Policy
– Now lets perform a welfare analysis.
• Free Trade
– Consumer Surplus
– Producer Surplus
• With the Tariff
– Consumer Surplus
– Producer Surplus
– Government Revenue
• Cost and Benefits
– Big player
– Small player
Price, P
S
= consumer loss (a + b + c + d)
= producer gain (a)
= government revenue gain (c + e)
PT
PW
a
b
c
d
e
P*T
D
S1 S2
D2 D1
Quantity, Q
QT
– The two triangles b and d represent an efficiency loss to the
economy as a whole and the rectangle e measures the gain
arising from the change in the terms of trade.
– The efficiency loss arises because producers and consumers act
as if imports were more expensive than they actually are.
b = is the production distortion loss
d = is the consumption distortion loss
– The terms of trade gain arises because a tariff lowers foreign
export prices.
– If the terms of trade gain is greater than the efficiency loss, the
tariff increases welfare for the importing country.
“In the case of a small country, the tariff reduces welfare for
the importing country.”
4
The Instruments of Trade Policy
• Other Instruments of Trade Policy
– Export Subsidies
• The effects on prices are exactly the reverse of those of
a tariff.
• An export subsidy will cause shippers to export the
good up to the point where the domestic price exceeds
the foreign price by the amount of the subsidy
• Welfare Analysis
–
–
–
–
Consumer Surplus
Producer Surplus
Cost of Government subsidy
Unambiguous result!!
Price, P
S
PS
Subsidy P
W
a
c
b
= producer gain
(a + b + c)
= consumer loss (a + b)
d
f
e
P*S
g
= cost of
government subsidy
(b + c + d + e + f + g)
D
Quantity, Q
Exports
The Instruments of Trade Policy
– Import Quotas
• Always rise the domestic price of the imported good
• Defining quota rents
• Welfare analysis
–
–
–
–
Consumer Surplus
Producer Surplus
Quota rents
Cost and benefits: well it depends…
5
Price, $/ton
Supply
= consumer loss
(a + b + c + d)
= producer gain (a)
Price in U.S. Market 466
World Price 280
a
b
c
d
= quota rents (c)
Demand
5.14 6.32 8.45 9.26
Import quota:
2.13 million tons
Quantity of sugar,
million tons
The Instruments of Trade Policy
–
–
–
–
Voluntary Export Restraints
Export Credit Subsidies
National Procurement
Red-tape Barriers
• The Summary says it all!!
– Table 8-1
6